3
Evaluating the Present Finance System

This chapter is a summary of evidence relevant to evaluating existing highway and transit finance arrangements. Chapter 1 observed that the finance system ought to be judged on the basis of its effect on the performance of the transportation system. The measure of performance is the benefits derived from highways and transit in return for their costs. The elements of the finance system are the fees users pay, sources of funds, and the rules and practices that govern spending decisions. Each of these elements influences performance. User fees influence whether facilities are used efficiently because they discourage trips that travelers value little in comparison with the cost of providing them. Also, the revenue available from user fees and other sources is a constraint on decisions to build and upgrade facilities. If existing facilities are inefficiently operated (that is, if they are producing net benefits that are less than they could produce with better management or pricing), if capital spending is not being reliably directed to high-payoff projects, or if low-payoff projects are receiving funds, then the finance system is not giving travelers and transportation agencies the feedback that a well-designed system could provide to guide decisions.

As Chapter 1 also described, in political discussions the transportation finance problem is defined primarily as a problem of revenue adequacy, and proposals for new finance arrangements commonly take the form of packages of revenue enhancements designed to meet a target.1 The effect of finance on performance

1

For example, a 2004 state revenue proposal was reported as follows: “[The governor] proposed raising nearly $250 million for transportation projects throughout the state … by increasing fees and fines on speeders, drunk drivers and anyone who owns a car. Under the plan, … vehicle registration fees would jump from $81 to $128 every two years for most cars and from $108 to $180 for larger cars and SUVs. Moving violations would carry a $50 surcharge…. And a conviction for drunken driving would come with … an extra $200 fee. The plan would also dedicate taxes on rental cars entirely to transportation projects…. Together with previously announced plans to increase driver’s license fees



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The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 3 Evaluating the Present Finance System This chapter is a summary of evidence relevant to evaluating existing highway and transit finance arrangements. Chapter 1 observed that the finance system ought to be judged on the basis of its effect on the performance of the transportation system. The measure of performance is the benefits derived from highways and transit in return for their costs. The elements of the finance system are the fees users pay, sources of funds, and the rules and practices that govern spending decisions. Each of these elements influences performance. User fees influence whether facilities are used efficiently because they discourage trips that travelers value little in comparison with the cost of providing them. Also, the revenue available from user fees and other sources is a constraint on decisions to build and upgrade facilities. If existing facilities are inefficiently operated (that is, if they are producing net benefits that are less than they could produce with better management or pricing), if capital spending is not being reliably directed to high-payoff projects, or if low-payoff projects are receiving funds, then the finance system is not giving travelers and transportation agencies the feedback that a well-designed system could provide to guide decisions. As Chapter 1 also described, in political discussions the transportation finance problem is defined primarily as a problem of revenue adequacy, and proposals for new finance arrangements commonly take the form of packages of revenue enhancements designed to meet a target.1 The effect of finance on performance 1 For example, a 2004 state revenue proposal was reported as follows: “[The governor] proposed raising nearly $250 million for transportation projects throughout the state … by increasing fees and fines on speeders, drunk drivers and anyone who owns a car. Under the plan, … vehicle registration fees would jump from $81 to $128 every two years for most cars and from $108 to $180 for larger cars and SUVs. Moving violations would carry a $50 surcharge…. And a conviction for drunken driving would come with … an extra $200 fee. The plan would also dedicate taxes on rental cars entirely to transportation projects…. Together with previously announced plans to increase driver’s license fees

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The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 usually has not received explicit consideration. Public officials have, however, generally respected certain historical principles in developing finance arrangements. These include the practice of user fee finance (motorists pay special taxes according to their use of roads, and revenue from these taxes covers highway spending); trust funds to keep track of the balance between fee revenue and spending; cost allocation rules that dictate higher charges for heavy than for light vehicles; and a division of revenue-raising responsibility and spending authority among the federal, state, and local governments. The question this chapter addresses is whether the principles that public officials rely on have led to finance arrangements that promote good performance. Alternative sets of principles for transportation finance are in use or have been proposed. Other U.S. transportation modes follow different practices with respect to reliance on user fees and federal involvement in funding (see Table 2-6 in Chapter 2). It is probable that the performance of these modes would be greatly altered if they were to adopt finance systems more similar to the one used for highways. In most other countries, no connection exists between highway spending and the revenues generated by fuel taxes and vehicle fees, and it has been proposed that the United States follow the more common practice internationally in this regard. Finally, proposals for expanded use of tolling and for road use metering and charging, which will be examined in Chapter 5, represent fundamentally different finance practices. A confident evaluation of the effect of present finance arrangements on performance is not possible with available information. Transportation agencies seldom conduct economic evaluations of their operations or of completed capital projects (GAO 2005). There have been few analyses of how changes in the structure of highway user fees changed users’ behavior or of how the practice of trust fund finance in highways or other modes has influenced total spending and project selection. Therefore, only fragmentary evidence can be cited in this chapter, and conclusions are tentative. Better information derived from systematic evaluations of finance practices will be necessary to guide successful policy reforms. The first section below reviews criteria that have been applied for evaluating revenue sources for government-owned highways and transit. The next two sections review evaluations of the overall performance of the U.S. highway and transit industries from the standpoint of economic efficiency—that is, whether the level of spending is justified, whether capital spending has been directed toward the projects with the best returns, and whether existing capacity is efficiently and collect more taxes from corporations, the proposal would pump an additional $266 million into the transportation trust fund” (Montgomery 2004). This perspective also was expressed in congressional testimony by the Executive Director of the American Association of State Highway and Transportation Officials (AASHTO) on the federal-aid program: “needs continue—by anyone’s measures—to far outstrip available … resources…. AASHTO is seeking a substantial increase in funding … for both highway and transit programs…. The challenge is how to fashion a funding solution that can achieve these goals and garner the bipartisan support needed for enactment” (Horsley 2002).

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The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 managed. These evaluations provide evidence on whether the institutions and practices that govern finance have tended to promote prudent spending. The fourth section examines how certain features of the existing finance system, including user fees, the practice of dedicating revenues from users to specified purposes, and the federal structure of the system, may affect government transportation programs. These features are relevant because they influence the cost-effectiveness of spending today and because they would require revision if new funding sources are introduced. CRITERIA FOR EVALUATING FUNDING SOURCES A standard set of criteria has evolved in past evaluations of tax alternatives and sources of funds for public infrastructure programs. Box 3-1 shows criteria from two sources, the Oregon Road User Fee Task Force study described in Chapter 1 and a study of funding alternatives prepared for the state departments of transportation through the National Cooperative Highway Research Program (NCHRP). The criteria proposed in the NCHRP study were derived from a review of about a dozen tax studies carried out by state governments mainly in the 1980s. The criteria in all the studies involve revenue adequacy, administrative feasibility or cost, and some fairness or equity concept. All the studies seem to accept as a premise that a dedicated revenue source is sought; that is, that transportation expenditures are to be funded by revenue from identified taxes or fees. These lists together contain all the relevant considerations, but definition and application of some of the criteria have been difficult. Equity or fairness is given diverse and sometimes subjective definitions. As noted in Chapter 1, the concept of efficiency often is vaguely defined or missing. (It is missing from the Oregon study’s list, even though the study recommends congestion pricing.) Few if any of the original studies attempt to quantify efficiency impacts of alternative transportation tax or fee schemes. The difficulty that governments have experienced in defining measures of fairness and efficiency that provide useful direction on highway funding is illustrated by the highway cost allocation studies. These studies have been conducted periodically since at least the 1950s by the federal government and by many states to determine the relative taxes or fees that should be charged to different classes of vehicles—in particular, to large trucks. To establish criteria for evaluating the federal highway user fee schedule, the federal studies have sought to follow the declaration of policy in the 1956 highway act, which created the Federal Highway Trust Fund: “if it hereinafter appears … that the distribution of the tax burden among the various classes of persons using the Federal-aid highways, or otherwise deriving benefits from such highways, is not equitable, the Congress shall enact legislation in order to bring about … such equitable distribution” (Highway Revenue Act of 1956, P.L. 627, June 29, 1956, Section 209). The federal study authors

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The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 BOX 3-1 Examples of Criteria Used to Evaluate Highway Funding Alternatives Oregon Road User Fee Task Force (Whitty 2003, 23) (The task force was charged by the legislature with designing new revenue sources to support Oregon roads and replace the existing sources.) Criteria for new revenue sources: Any new revenue system should be founded on the principle that users pay. Revenue sources traditionally the province of local government should not be usurped by the state. New sources should generate sufficient revenue to replace the fuel tax. Financing should be transparent: fees should be visible to payers and the public should know how much they are paying and how rates are calculated. The costs of collection and of payers’ record keeping should not be substantial financial burdens. Revenue collection must be enforceable. The new system must support all roads of the state and local governments. Any new revenue source should be acceptable to the public. NCHRP Report 377: Alternatives to Motor Fuel Taxes for Financing SurfaceTransportation Improvements (Reno and Stowers 1995, 49–51) Criteria for evaluating tax alternatives (derived from a review of tax studies produced by 13 states): Adequacy: Yield in relation to need, uses, investment requirements Responsiveness to inflation Stability of revenues over time Potential for needed increases Equity: With respect to costs occasioned With respect to ability to pay and benefits received By geographic area In perception as well as in fact

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The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 Efficiency: Bringing about better decisions on travel and investments Paying costs imposed on others Creating disincentives for undesirable activities Enabling economic growth Simplicity: Administrative cost Compliance cost Enforcement cost Evasion potential have interpreted this declaration to require that the share of fee revenue generated by each of a number of vehicle classes (i.e., cars in each of several size classes and trucks in classes defined by size and axle configuration) should equal the share of government expenditures attributable to each class’s use of the highways. The federal studies acknowledge efficiency as an ideal criterion but do not apply it to discriminate among tax alternatives2 (USDOT 1997, VI-22–VI-29). Past Transportation Research Board (TRB) committees noted that the missing analysis in the highway cost allocation studies is an evaluation of how adjustments in the structure of user fees would affect the economic benefits derived from the highway system. A TRB committee studying the social costs of transportation advised that “practical constraints on user fee policies—revenue requirements and considerations of administrative and political feasibility—do not preclude promoting efficiency through user fees…. For any two fee options under comparison, … one will encourage economically beneficial use of the facility more than the other. These differences ought to be weighed carefully in decisions on tax policy” (TRB 1996, 126–128). A committee on cost allocation offered step-by-step guidelines for analyzing the effects of changes in user fees on highway performance and benefits (Committee for the Review of the Federal Highway Cost Allocation Study 1996, 4–6). 2 The 1997 federal study contains comparisons of estimates of marginal costs of highway travel (including congestion costs) with user fees. This approach to assessing whether fees promote efficiency is insufficient because it provides no basis for judging whether the correspondence between fees and costs is “close enough.” The NCHRP study cites discussions of efficiency in the state transportation funding studies, but no example of a study that used efficiency as a quantitative criterion for comparing alternatives (Reno and Stowers 1995, 103–110).

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The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 The elements of a comparison of user fee alternatives on the basis of their effect on the benefits derived from highways are illustrated in the Brookings Institution study of road user charges, Road Work. The study compared the savings from charging trucks for pavement wear through an ideal pricing scheme with savings if a simplified tax schedule were applied (Small et al. 1989, 71–74). The ideal pricing case assumes that each large truck is charged a fee per mile that depends on the number and spacing of the truck’s axles, the load on each axle, and the road that the truck is traveling on. The fee would equal an estimate of the actual increment in the highway agency’s pavement maintenance cost caused by each trip of the truck on the road. The charge would depend on the road because the wear a truck causes depends on pavement thickness and other roadway characteristics. In the simplified fee case, each truck is charged a fee per mile that depends on its axle configuration and axle loads but is the same for all roads and is set so as to maximize the highway agency’s savings, less the added costs to shippers and carriers (not counting fee payments). In both cases, it is assumed that the highway agency designs pavements to minimize the sum of vehicle operating costs and agency construction and maintenance costs. The following are the study’s estimates of changes in highway agency pavement costs and in shipper and carrier costs if such charges were imposed, compared with costs if actual user fees were continued (Small et al. 1989, Tables 4-2, 4-4) (figures are in billions of 1982 dollars): Item Ideal Pricing Simplified Fees Change in highway agency pavement costs −2.1 −1.8 Change in shipper and carrier costs before user fee payments 0.4 0.4 Change in user fee payments −0.6 0.8 In both scenarios, highway agency costs decrease (by $2.1 billion annually in the ideal pricing scenario and $1.8 billion with simplified pricing), primarily because of the change in pavement designs but also because the new fees induce truck operators or shippers to reduce axle loads, change truck configurations, shift some freight to rail, and (in the ideal pricing scenario) change routes to travel on roads with stronger pavements. Ideal pricing increases pavement wear savings only moderately compared with the simplified fees (by $2.1 billion minus $1.8 billion, or $300 million annually). In both scenarios, shipper and carrier costs before user fee payments increase (by $400 million annually) because of the changes in their operating practices induced by the fee changes. In the ideal pricing scenario, user fees paid by carriers decline and shippers and carriers realize a net gain of $600 million annually. However, in the simplified fee scenario, user fee payments increase by $800 million annually (because fees must be raised even on roads with low pavement costs in order to attain the optimum systemwide pavement savings), and shippers and carriers suffer a net loss.

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The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 Selection between the two tax schemes would be a policy choice that weighed the trade-offs involved. The potential economic benefit under ideal pricing would be greater, and the option would have the practical attraction that both shippers and highway agencies would gain. Potential savings from the simplified pricing system would be only a little less, and the fee scheme would be easier to administer, but the high fees required to gain the pavement savings might make the option politically unattractive. This example is presented here not for the significance of its quantitative results [the authors of the study acknowledge that their estimation methods are very approximate, the data are now old, and the magnitudes of some impact estimates may have been distorted by problems in the U.S. Department of Transportation (USDOT) data employed)] but to illustrate the kind of comparison of economic consequences that ought to be the basis of evaluations of all transportation user fee schemes. Projections of economic impacts will always be uncertain; however, in practice, once an initial evaluation is made and a fee change put into effect, the consequences can be monitored and fees readjusted on the basis of new information. In summary, the tax policy studies show that the criteria that the states and Congress recognize are revenue adequacy, fairness, and administrative practicality. Actual tax policies are driven by the objective of meeting revenue targets; however, in enacting transportation funding arrangements, governments generally have respected the user fee finance principle because it is seen as practical and fair. Explicit consideration of how changes in user fees and other funding arrangements will affect transportation system performance or the economic benefits derived from transportation programs seldom enters into finance or fee decisions. Nonetheless, it would be possible to compare fee alternatives on this basis and gain useful guidance for policy if a program were put in place to evaluate systematically the impacts of fees on the behavior of highway users and on the costs and benefits of the highway program. HIGHWAY SYSTEM PERFORMANCE This section summarizes estimates of the return earned by highway investments in recent decades. This information will help decide whether present finance arrangements are promoting sound decisions on capital spending levels and project selection. It was argued above that one mechanism by which present finance arrangements may affect system performance is through limiting total spending. A facility that provided a service whose value to users was less than the cost of providing the service probably could not generate enough revenue from user fees to sustain itself in the long run. Also, because fee levels are tied to spending, users have an incentive to oppose spending on a facility that is worth less to them than the

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The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 fees they pay. Therefore, user fee finance, as it is practiced in the highway program, might be expected to reduce the risk of overspending, that is, spending to provide services that are not justified by their benefits. In contrast, it might be expected that the risk of overspending is greater in other public infrastructure programs in which spending is not effectively limited by revenue from users, for example, inland waterways (where user fees cover one-eighth of total expenditures; see Table 2-6) and passenger rail (where fare revenue covers approximately half of expenses). In opposition to this argument, critics of user fee finance have characterized dedicated highway user fee revenues as a cash cow providing funds regardless of justified needs and argue that public officials would do a better job of targeting funds to worthwhile applications if they were unhindered by the constraints of trust funds and dedicated taxes. Evidence concerning the economic return on highway investments would help in judging which of these two points of view is more accurate. If incremental investments are found to earn high rates of return, the case for the view that user fee finance promotes overspending is weakened and the view that present finance arrangements are a positive influence is strengthened, However, such evidence alone would not prove the linkage between present finance arrangements and performance. The estimates discussed in this section include results from the latest of a biennial series of federal reports to Congress (formerly called the National HighwayNeeds reports and now the Conditions and Performance reports) on the performance of the highway system and several estimates by economists of incremental rates of return on highway investment. It has already been noted that quantitative information on the benefits of highway investment is much weaker than would be desirable for sound policy guidance. Results from the Conditions and Performance studies are not presented here with the intent of arguing that highway spending should be increased.3 As Chapter 1 states, the committee has not considered whether the present rate of transportation spending is too high or low, and its task does not involve finding revenue mechanisms capable of supporting increased spending. Rather, the studies’ results are examined solely to investigate whether historical spending levels have been economically justified. Because users of roads are not charged market prices, the benefits of road improvements to users must be estimated from various sources of information about the effect of road conditions on travel time, vehicle operating costs, and other components of the total cost of transportation. The absence of market pricing does not invalidate the estimates of the benefits of incremental expansions of 3 The studies are commonly used for this purpose, e.g., by AASHTO (AASHTO 2002) and the Chamber of Commerce (Cambridge Systematics 2005).

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The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 the highway system presented below; however, if prices more closely reflected costs, greater benefit could be derived from existing facilities and service quality could be maintained in the future at lower total cost. Also summarized below are results of studies that estimate savings from better pricing. Appendix A presents the estimates from the studies summarized here in more detail and describes the studies’ methods, including some important shortcomings. Federal Highway Conditions and Performance Studies USDOT submits biennial reports to Congress that project the effects of alternative levels of highway capital spending (for all levels of government) on highway performance and highway user costs (travel time, vehicle operating costs, and accident costs). The 2002 study projections, for the period 2001–2020, indicate that if all highway capital projects nationwide with a benefit–cost ratio greater than 1 were carried out, annual capital spending over the period would average 65 percent higher than actual 2000 spending. To maintain overall conditions and performance at 2000 levels, annual capital spending 17 percent higher would be required (USDOT n.d., ES-14). The 2002 study did not report rates of return. However, the previous study reported that if all projects with benefit–cost ratio greater than 1 were carried out over the 20-year period 1998–2017, the average benefit–cost ratio would be 3.7 (USDOT 2000). In comparing the mix of kinds of projects that highway agencies were carrying out in recent years with the mix of kinds of projects that would be most beneficial, the 2002 study concluded that benefits would be increased if agencies shifted spending from system preservation to capacity expansion (USDOT n.d., iii). The 2002 study concluded that physical conditions of highways were unchanged or slightly improved during the 1990s. Performance was found to have deteriorated: the fraction of all travel on freeways and principal arterial streets that occurred under congested conditions increased. The projections show that, although spending more would slow the rate of deterioration, at all future spending levels analyzed up to the maximum economically justified level, congestion delay will increase or will be little improved (USDOT n.d., 9-8). In summary, the USDOT Conditions and Performance studies indicate that the direct benefits to highway users of additional capital spending for highway system preservation and expansion would exceed the cost to the government and that spending would have to expand to a level substantially greater than present spending before highway agencies ran out of worthwhile projects. This conclusion implies a high marginal rate of return to increased spending and that total spending historically has been constrained within economically justified limits.

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The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 Productivity Benefits of Highway Investment A series of economic studies has examined how highway infrastructure affects business costs for the national economy or for industry groups. Results of four such studies are outlined below. The first two measured the effect of highway investment on particular costs that have an evident link to highways: trucking company costs and industry inventory costs. The final two take a more aggregate approach and examine the historical contribution that expansion of the highway system has made to productivity growth in broad industry classes. In spite of the differences in methods among the four studies, they all are attempts to measure approximately the same category of benefits. Savings in truck freight and the consequent savings in logistics costs (estimated in the first two studies) are the initial steps in a chain of transfers of the benefits of improved highway transportation. This chain leads to overall productivity growth (measured in the second pair of studies) and ultimately to lower prices for the goods and services that consumers purchase and to higher incomes. All of these studies’ estimates exclude, by design, major components of highway benefits; in particular, they leave out most or all of the benefits of passenger travel. The findings, which are representative of recent credible research on the national economic return to highway investment in the United States, were as follows: The study of trucking (Keeler and Ying 1988) estimated the relationship of total annual production costs in the intercity trucking industry to industry output, the prices of inputs, and external factors that influence productivity, including the stock of highway infrastructure, for 1950 to 1973. The results show savings, for the total of U.S. intercity truck traffic that would have occurred without the expansion of the highway system, reaching $6 billion to $9 billion annually by 1973 (in 1973 dollars). These savings justified between 33 and 80 percent (depending on assumptions about interest rates) of the capital cost and 30 to 67 percent of the total cost of intercity highways during the period. Year-by-year estimates showed that by the early 1970s, the incremental benefits from increases in the highway capital stock were becoming very small. The inventory costs study (Shirley and Winston 2004) estimated the reduction in inventory holding costs and associated logistics costs in U.S. business caused by expansion of the highway system in the period 1973–1996. Transportation system improvements are expected to reduce inventory holding costs by increasing the speed and reliability with which firms can replenish inventory. The estimated annual rate of return on net investment in the highway capital stock was 18 percent during the 1970s (i.e., an additional dollar of net highway capital stock reduced costs by $0.18), 5 percent during the 1980s, and 1 percent during the 1990s.

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The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 The first of the two studies of the link between highway capital expansion and industry productivity growth (Fernald 1999) used data on production and inputs for 29 industry groups for the period 1953–1989. It estimated the relationship of growth in total factor productivity in each sector to growth in the national highway system. The results indicate that for the period as a whole, road expansion contributed strongly to productivity growth and that the return on additional road investment greatly exceeded the normal private-sector rate of return. Separate estimates for the pre- and post-1973 periods indicated that after 1973, the estimate of rate of return was not statistically different from the normal rate of return or from zero. The second industry productivity study estimated the contribution of highway capital to productivity in 35 industries and in the entire U.S. economy for the period 1950–1991 (Nadiri and Mamuneas 1998). The model was more detailed than that of the previously described study. It found annual rates of return on additional highway capital of 54 percent for 1960–1969, 27 percent for 1970–1979, and 16 percent for 1980–1991. That is, in the 1980–1991 period, an incremental addition to the highway capital stock produced annual cost savings in private business equal to 16 percent of the total social cost of providing the additional capital. The authors observe that by the end of the study period, rates of return on highway capital and private-sector capital appear to have converged. It is noteworthy that each of the four studies measured a decline over time in the benefits of incremental additions to the stock of highways. Interpreting the significance of this reported pattern is difficult because the timing of the declines is inconsistent among the four studies. The trucking cost study (Keeler and Ying 1988) and the first of the industry productivity studies (Fernald 1999) report that by the 1970s, the rate of return on highway expansion was nearing zero. However, the inventory cost study (Shirley and Winston 2004) and the second industry productivity study (Nadiri and Mamuneas 1998) measure 27 percent and 18 percent rates of return, respectively, during the 1970s. Of course, the four studies are measuring different components of total benefits, but the benefits measured are related, so consistent trends would be expected. The authors of the trucking cost study observe that a decline in the benefits of expansion in the 1970s would not be implausible since by the early 1970s the basic network of Interstate highways had been completed. The authors observe also that at this time, expansion of the capital stock slowed markedly (growth in the stock of roads was 5 percent per year in 1955–1975 and 1 percent per year in 1975–1985; see Figure 2-12). They speculate that this brake on growth could have been the rational response of governments to the decline in the benefits of expansion. The inconsistent results among the studies, as well as certain simplifying assumptions and uncertainties embodied in the estimates (as described in

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The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 governments. Understanding of the impacts of these two features will be necessary to guide either improvements in present arrangements or design of a long-term alternative. If the present system is basically sound, it will be valuable to extend its life span by reinforcing finance practices that contribute to its success and altering those that do not. For example, Chapter 2 described how pressures to find expedient funding are prompting some jurisdictions to decrease reliance on user fee revenue for transportation programs. If user fee finance has historically contributed to good performance, the risk involved in allowing the practice to erode ought to be considered in such decisions. Similarly, if adjustments to the rules of the federal-aid program could promote more cost-effective state and local government spending choices, such actions would reinforce the existing federal structure of transportation programs and extend the life of the present finance system. If the nation eventually develops fundamentally new finance arrangements that rely more on direct charging for highway use (for example, through expanded use of tolls and road use metering, as Chapter 5 describes), governments will need to reconsider both these features of the finance system (the federal structure and the link between fee revenue and spending). With direct charging, the capability of states and local jurisdictions to collect fees from all users of their roads would be enhanced, so the historical justification for intergovernmental aid would be diminished, and jurisdictions would expect to control the revenue generated by the roads that they own. If the road user fees in the new charging scheme properly reflected costs, it would be appropriate to have tighter links between revenue and spending than exist today, because the revenue that each link in the road network generated would be the best indicator of the value of expanding that part of the network. Present practices with regard to government responsibilities, trust funds, and dedicated revenues were developed in the context of the existing scheme of funding sources. Simply substituting new sources for the existing ones while leaving all other finance practices untouched probably will not be practical or desirable. The following two sections briefly outline key questions concerning the impacts of user fee finance and the federal structure of finance on the performance of government transportation programs. Adequate information for answering many of the questions is not available. Chapter 6 reviews proposals from various sources for changing certain of these features to improve performance. User Fee Finance and Dedicated Revenues Chapter 2 outlined federal highway finance practices. Most states’ finance practices parallel the main features of the federal program—user fees, trust funds, and dedication of fee revenues for specific purposes. This collection of practices influences total spending, spending priorities, the use of roads and transit, and consequently the benefits of transportation programs. That is, the outcomes of transportation programs would be different if alternative practices were employed

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The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 (for example, eliminating the connection between user fee revenue and spending). The following practices are the elements of user fee finance in the highway program: Imposing highway user fees (principally motor fuel taxes and vehicle registration fees); Matching the fees, to some extent, to the government’s costs of providing services; Dedicating most revenue from the fees to highways and transit, with trust funds to enforce the connection between revenue and spending; and Deriving most highway funding from highway user fee revenues. This finance arrangement is the outcome of two independent policy decisions, each of which should be evaluated on its own merits: the decision to impose fees related (to some extent) to costs and the decision to depend primarily on fee revenue to fund highways. User Fees The practice of charging fees to highway users generally has not attracted criticism (although the level and form of fees can be controversial). The federal government, all the states, and most other developed countries impose special fees or taxes on road users, and similar charges are imposed on users of other government-provided transportation facilities in the United States. Even if they are uncontroversial, user fees can be harmful if the charges that travelers incur for many trips exceed the added cost to the public of providing those trips. User fees can promote efficient use of facilities if they bear at least a degree of correspondence to the public’s costs of providing the facilities. Then users will make decisions (e.g., whether to make a trip, whether to travel by car or bus, what size of freight truck to use, whether to ship by truck or rail) that take these costs into account. Fees set too low allow wasteful use of facilities, and fees set too high needlessly discourage travel. Many studies have compared highway user fees with costs. One recent economic study that considered congestion, pollution, and the external costs of highway accidents concluded that, in the absence of more effective policies to address these costs (for example, peak period charges that reduced congestion), the optimal gasoline tax in the United States would be $1 per gallon (Parry 2002) (the actual average rate is $0.38 per gallon). (A tax at this level would discourage much travel on uncongested rural roads that was valuable to travelers and had low cost.) Of the $1 per gallon estimate, $0.20 would serve to substitute fuel tax revenue for some of the revenue now derived from income taxes. The public could benefit

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The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 from such a substitution because all taxes distort private economic decisions and thus cause economic losses. For example, road user taxes in excess of the costs of travel cause the loss of some valuable travel, and income taxes reduce employment. The study estimated that up to $0.20 per gallon, the added loss of this kind from the fuel tax would be less than the gain from lower income taxes. In another study, a TRB committee compared prices with costs of freight transportation by truck, barge, and rail. The committee considered infrastructure, pollution, congestion, and accidents. It found that, for typical trips where the modes compete, the mismatch between prices (including user fees for public infrastructure) and costs for trucks usually was smaller than the mismatch for barges and greater than for rail (TRB 1996, 6–10). Chapter 6 describes proposals from federal highway cost allocation studies and past TRB committees for improving the alignment between present highway user fees and costs. Introduction of road use metering or other forms of congestion charging, as described in Chapter 5, would be needed to allow fees to reflect adequately the congestion costs that road users impose on others. Dedicated Revenues The other main feature of user fee finance in the highway program—the practice of tying spending on a particular government program to revenue from a particular tax—has been controversial. Analyses of dedicated taxes have produced at least four competing assessments: Dedicated taxes are harmful because any constraint that prevents government officials from allocating funds to the activities that will yield the greatest benefit will reduce public welfare. In this view, the revenue a particular tax happens to raise in a time period is a poorer guide to appropriate spending than the judgment of officials (Wilkinson 1994, 122; Buchanan 1963, 457). Dedicated taxes are justifiable as an expediency to gain public acceptance of certain worthwhile taxes or programs and to provide financial stability, even if the practice does tend to reduce the efficiency of government spending by limiting officials’ flexibility. According to this pragmatic view, citizens who are skeptical of the benefits of general tax increases are more likely to acquiesce to a tax that is presented as supporting a specific popular program (Farrell 1999, 59; Wilkinson 1994, 120–122, 132). The financial stability provided by guaranteed revenue is viewed as necessary in an infrastructure program that must construct and operate large, long-lived facilities. Dedicated taxes promote efficient government by giving taxpayers more direct control over the uses of tax revenue. In this view, the constraint that earmarking places on the independence of government budget makers is

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The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 likely to enhance rather than reduce the efficiency of public spending decisions in many circumstances, because citizens know best what programs are worth and public officials often have biases stemming from their bureaucratic interests. Under general fund budgeting, the main choice for each citizen is whether to support higher or lower general taxes, and each citizen must speculate as to whether raising general taxes will sufficiently increase spending on the services he or she most values to make the general tax increase worthwhile. In contrast, dedicating tax revenues to particular uses creates opportunities for more direct citizen input to individual program funding decisions (Buchanan 1963). Dedicating taxes has little or no impact. Government officials generally have enough budgeting flexibility, despite restrictions from dedicated taxes, that total spending and spending allocations end up close to the amounts that would occur under general fund financing. In this view, it is a deception to lead taxpayers and voters to believe that dedicating taxes controls or guarantees spending choices when in reality it does not (Patashnik 2000, 188; Wilkinson 1994, 122). These views are hypotheses about the merits of dedicated tax financing in general, including such applications as school district property and sales taxes to fund education. The highway finance system is a special case; because the dedicated taxes are user fees, they may have consequences that differ from those of dedicated broad-based taxes (such as a school district tax). Specifically, the willingness of highway users to pay the fee conveys some information about the value of the highway facility. It was argued above that reliance on dedicated revenue from user fees may reduce the risk of overspending, because a facility that produced little benefit would not generate fee revenue sufficient to sustain it and because users will not lobby for added spending that entails fees higher than the value to them of the improved service. Demonstrating that transportation spending is constrained in this way would require research, but there is some evidence in support of the assertion. National highway spending has historically tracked user fee revenue fairly closely (Table 2-3), although spending exceeds revenues and there have been periods of divergence (e.g., 1972–1982 and 1997–2003). Another sign of how finance practice constrains spending was the 2-year delay in reauthorization of the federal surface transportation aid program between the expiration of the previous program in 2003 and enactment of the Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy for Users (SAFETEA-LU) in 2005. The obstacle to action in that period was the gap between desired spending and projected revenue from user fees. Gaining the efficiency benefits of charging fees to highway users does not require that the revenues raised be dedicated to highways. User fees are beneficial

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The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 as long as they induce reductions in costs of highway travel (for example, congestion, pollution, or road wear costs) that are greater than the value of lost travel benefits to highway users who forgo or alter travel because of the fees. It was noted above that if the charge for each trip is the marginal cost of the trip (that is, the added cost of the trip to the system operator, other users, and the public), and the highway agency invests in expanding links of the system that are generating surplus revenue, then the highway system will evolve toward the economically optimum scale and the fee revenue will approximate the spending needed to support it. However, if fees are not equal to marginal costs (for example, if a monopolist set fees so as to maximize revenue), then, in the case of a service like highways that users value highly and whose use is fairly insensitive to price, the fees could generate large revenues, in excess of the economically justified level of road spending. The possibility of excess revenue has been a long-standing objection to dedicated funding for highways, whether from fuel taxes or tolls.8 The legitimacy of this concern is difficult to assess because of lack of evidence. If road charges were set to maximize revenue and all revenue was then spent on expanding capacity, the likely result would be a growing capacity surplus and low or negative returns on investments for incremental capacity expansion. However, the evidence presented in the section above on highway system performance suggests that historically, incremental highway expansions have yielded good returns on average. Comparison of tax rates and revenues in the United States with those in Europe (where the gasoline fuel tax rate typically is 10 times higher than in the United States and revenues generally are not dedicated) suggests that U.S. rates are far below the revenue-maximizing rates. It has been argued that dedication of revenue tends to suppress fuel tax rates by making the fuel tax a less useful revenue-raising instrument in the eyes of legislators (Pisarski 2004). Evidence for another supposed effect of dedicating tax revenue—that it gains public support for user fees or other taxes—is mainly anecdotal. The following are examples: In debates over transportation finance in Pennsylvania, rural and small town legislators are reported to have opposed proposals to increase highway user fees to pay for transit but to have supported a broad-based transit tax plus user fee increases dedicated to highways (Barnes 2005). 8 For example: “The net result [of tying spending to revenue from road pricing] could be an inexhaustible supply of capital for highway investment unrelated to desired levels that might otherwise be formulated from policy planning considerations at the local or national level” (Sitton 1965); and “Originally intended to ensure completion of the interstates [the Highway Trust Fund] is now primed to sponsor much superfluous road construction. A bulging stream of proceeds from the trust’s ‘user fee’ (gas-tax income) is presumed to pay for each new mile of concrete and macadam…. Few other advanced nations have hitched the financing of their transportation systems to a cash cow of this sort” (Nivola 1999, 69).

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The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 Proponents of devolution of highway finance responsibilities from the federal government to the states regularly cite diversion of federal user fee revenue from highways to other purposes as a primary argument for abolishing the federal gas tax (e.g., Utt 2004, 2). A referendum calling for dedication of state highway user fee revenue to transportation passed by a 79 percent majority in Missouri in 2004 (ARTBA 2004). The history of transportation funding referenda suggests that the more specific the proposed uses of the revenue, the more likely it is that voters will support the tax (Ernst et al. 2002, 5–11; Center for Transportation Excellence 2004). Experience in Europe runs counter to the claim that dedication of revenues is necessary to gain support of fees. Taxpayers there have been willing to accept very high fuel excise tax rates, although most revenue is not dedicated to transportation and some toll revenues have been dedicated to nonhighway purposes. However, the direction of European transport finance reform may be toward U.S.-style user fee finance with dedicated taxes (Commission on Transport Infrastructure Funding 2000). In view of the fundamental importance of dedicated tax revenues to the financing of transportation programs in the United States, it is unfortunate that better information is not available for assessing the conflicting claims concerning the impacts of the practice. Research could evaluate the effect of the practice on total spending, public support for taxes, and the quality of government spending decisions. Despite the uncertainties, it appears that the practice of user fee finance in the highway program has positive consequences and that allowing the practice to erode would risk a decline in the performance of transportation programs. User fee finance appears in some cases to earn public support for specific programs, although systematic evidence for this effect is lacking. It provides stability and may promote efficiency through the budget constraint it imposes and through the influence of fees on user decisions. Federal, State, and Local Government Responsibilities Chapter 2 described the division of responsibilities among the federal, state, and local governments for finance and for operation of transportation programs, and it outlined the rules governing the federal-aid highway program with regard to allocations of grants among the states, project eligibility, project design, and contracting and labor practices requirements. These two related aspects of the federal structure of transportation finance—the division of responsibilities and federal program rules—exert a major influence on program outcomes.

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The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 Chapter 1 stated, as a guideline for policy, that the lowest level of government (federal, state, or local) that represents most of the population that uses and benefits from a transportation facility ought to be responsible for providing and funding the facility. That is, ideally, local governments would provide local streets and transit; states, regional facilities like intercity roads; and the federal government, facilities whose scope genuinely demands a national perspective in planning, like the Interstate highway system or the air traffic control system. The advantage of following this rule is that the governmental unit providing the facility is accountable to the users and beneficiaries of the facility, who also pay for it through their taxes and fees. Transportation budgets and priorities are then more likely to correspond to the services that the beneficiaries value most and are willing to pay for. The federal and state roles in highways and transit are greater today than this rule would appear to require, for three reasons. First, grants to lower levels of government have been used as a means of redistributing resources among regions of the country and between urban and rural areas. Second, cities and towns lack good mechanisms for charging the users of their streets and highways. Finally, the present federal highway program was designed with construction of the Interstate system—a genuinely national project—as its most important objective. Since the substantial completion of the Interstate program in the 1980s, proposals have regularly been made to reduce the federal government’s involvement in highways and transit. At the state level, a realignment of state and local responsibilities has occurred gradually, in part as the result of federal-aid program requirements that states give local governments more control over priorities for spending federal-aid funds in urban areas. Chapter 6 reviews a range of proposals for adjusting federal, state, and local roles, within the basic framework of existing finance arrangements, with the aim of increasing the cost-effectiveness of highway and transit spending. Chapter 5 describes proposals for introducing direct charging for road use through tolls or road use metering. By giving all governments the ability to raise revenues from all users of their roads, direct charging probably would entail a major restructuring of federal, state, and local responsibilities. The following are important issues concerning the effects of program rules in the existing federal transportation aid program: The impact of project eligibility rules on state project selection (federal grants carry numerous restrictions concerning the class of road or the type of improvement for which the state may spend the funds, including the restriction of nearly all highway grants to capital projects); The effect of federal engineering standards and planning requirements on the cost-effectiveness of projects and project selection; The significance of the geographical transfers that the federal-aid program accomplishes, among states and between urban and rural areas, from the standpoint of fairness and cost-effectiveness; and

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The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 The effect of the federal highway user taxes on state tax effort and the effect of federal-aid matching requirements on total state transportation spending. There is scope for reforms in federal-aid program rules that would allow the program to produce greater transportation improvement and fulfill federal goals more effectively. Studies from government and other sources have suggested how changing specific rules could improve results. For example, Government Accountability Office (GAO) reports have shown that, because the state matching share required in most federal-aid highway projects is small (usually 20 percent), much federal highway aid is in effect paying for general state spending and taxpayer relief rather than for expanding the highway system (GAO 2004); a Congressional Budget Office study noted how relaxation of federal restrictions on debt financing, tolling, and public–private partnerships has helped states to increase the value of federal aid, and assessed prospects for greater improvement in this direction (CBO 1998); and a study by a TRB committee showed how federal design rules affect costs of projects and state project selection decisions (TRB 1987). Revisions to federal-aid highway program rules would be a necessary element of any comprehensive proposal concerning reform of transportation finance at the federal level. In the 2005 reauthorization of the federal surface transportation aid program, Congress created two commissions to examine questions related to finance, the National Surface Transportation Policy and Revenue Study Commission [SAFETEA-LU Section 1909(b)] and the National Surface Transportation Infrastructure Financing Commission (SAFETEA-LU Section 11142). When the provisions in the charges of these commissions were under consideration during debate over reauthorization, GAO recommended that the mandate include consideration of options to redesign the structure and funding formulas of the federal-aid highway program, in order to increase the effectiveness of aid and better promote national goals (GAO 2004, 47). The commissions’ charges do not specifically refer to this task, but it would not be inconsistent with the broad definitions of the charges in the legislation. REFERENCES Abbreviations AASHTO American Association of State Highway and Transportation Officials APTA American Public Transportation Association ARTBA American Road and Transportation Builders Association CBO Congressional Budget Office FHWA Federal Highway Administration

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The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 FTA Federal Transit Administration GAO Government Accountability Office TfL Transport for London TRB Transportation Research Board USDOT U.S. Department of Transportation AASHTO. 2002. Transportation: Invest in America: The Bottom Line. Washington, D.C. APTA. 2004. Public Transportation Fact Book(55th ed.). March. ARTBA. 2004. Special 2004 Ballot Initiatives Report. Barnes, T. 2005. Rendell Lobbying to Rescue Transit. Pittsburgh Post-Gazette, Jan. 30, p. A-1. Buchanan, J.M. 1963. The Economics of Earmarked Taxes. Journal of Political Economy, Vol. 71, No. 5, Oct., pp. 457–469. Cambridge Systematics. 2005. Future Highway and Public Transportation Finance Phase I: CurrentOutlook and Short-Term Solutions: Executive Summary. National Chamber Foundation. CBO. 1998. Innovative Financing of Highways: An Analysis of Proposals. Jan. Center for Transportation Excellence. 2003. Election Issues. www.cfte.org/success/elections.asp. Commission on Transport Infrastructure Funding. 2000. Theses and Recommendations of the Government Commission on Transport Infrastructure Funding. www.bmvbw.de/Anlage5994/Theses-and-Recommendations-of-the-Government-Commission-on-Transport-Infrastructure-Funding.pdf. Sept. 5. Committee for the Review of the Federal Highway Cost Allocation Study. 1996. Letter Report. Transportation Research Board, National Research Council, Washington, D.C., May 30. Ernst, M., J. Corless, and K. McCarty. 2002. Measuring Up: The Trend Toward Voter ApprovedTransportation Funding. Surface Transportation Policy Project. Farrell, S. 1999. Financing European Transport Infrastructure: Policies and Practices in Western Europe. Macmillan. Fernald, J.G. 1999. Roads to Prosperity? Assessing the Link Between Public Capital and Productivity. American Economic Review, Vol. 89, No. 3, June, pp. 619–638. FHWA. 2004. Highway Statistics 2003. FTA. 2000. Transit Benefits 2000 Working Papers: A Public Choice Policy Analysis. FTA. 2004. National Transit Database: Transit Profiles All Reporting Agencies for the 2002 Report Year. GAO. 2004. Federal-Aid Highways: Trends, Effect on State Spending, and Options for Future ProgramDesign. Aug. GAO. 2005. Highway and Transit Investments: Options for Improving Information on Projects’ Benefitsand Costs and Increasing Accountability for Results. Jan. Gómez-Ibáñez, J.A. 1999. Pricing. In Essays in Transportation Economics and Policy: A Handbook inHonor of John R. Meyer(J.A. Gómez-Ibáñez, W.B. Tye, and C. Winston, eds.), Brookings Institution, Washington, D.C. Horsley, J. 2002. Testimony Before the Senate Finance Committee and Senate Environment and Public Works Committee. Sept. 25. Keeler, T.E., and J.S. Ying. 1988. Measuring the Benefits of a Large Public Investment: The Case of the U.S. Federal-Aid Highway System. Journal of Public Economics, Vol. 36, pp. 69–85. Meyer, J., J. Kain, and M. Wohl. 1965. The Urban Transportation Problem. Harvard University Press, Cambridge, Mass.

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The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 Mohring, H. 1965. Urban Highway Investments. In Measuring Benefits of Government Investments (R. Dorfman, ed.), Brookings Institution, pp. 231–291. Montgomery, L. 2004. Ehrlich Urges Vehicle Fee Increase for Transportation: Speeders, Drunk Drivers Also Targeted, but Gas Tax Exempt. Washington Post, Feb. 14, p. B1. Nadiri, M.I., and T.P. Mamuneas. 1998. Contribution of Highway Capital to Output and Productivity Growth in the U.S. Economy and Industries. www.fhwa.dot.gov/policy/gro98cvr.htm. Federal Highway Administration, Aug. Nelson, P., I.W.H. Parry, and M. Wachs. 2002. Is Northern Virginia Voting on the Right Transportation Tax? State Tax Notes, Oct. 28, pp. 271–275. Nivola, P.S. 1999. Laws of the Landscape: How Policies Shape Cities in Europe and America. Brookings Institution Press. Parry, I.W.H. 2002. Is Gasoline Undertaxed in the United States? Resources, Issue 148, Summer, pp. 28–33. Patashnik, E.M. 2000. Putting Trust in the U.S. Budget: Federal Trust Funds and the Politics of Commitment. Cambridge University Press, Cambridge, United Kingdom. Pisarski, A.E. 2004. Reconsidering the FHTF. Regulation, Spring, pp. 12–13. Reno, A.T., and J.R. Stowers. 1995. NCHRP Report 377: Alternatives to Motor Fuel Taxes for FinancingSurface Transportation Improvements. Transportation Research Board, National Research Council, Washington, D.C. Safirova, E., K. Gillingham, I. Parry, P. Nelson, W. Harrington, and D. Mason. 2004. Welfare and Distributional Effects of Road Pricing Schemes for Metropolitan Washington, D.C. In RoadPricing: Theory and Evidence(G. Santos, ed.), Elsevier, Oxford, United Kingdom, pp. 179–206. Shirley, C., and C. Winston. 2004. Firm Inventory Behavior and the Returns from Highway Infrastructure Investments. Journal of Urban Economics, Vol. 55, March, pp. 398–415. Shrank, D., and T. Lomax. 2003. The 2003 Annual Urban Mobility Report. Texas Transportation Institute, College Station, Sept. Sitton, P. 1965. Comments. In Measuring Benefits of Government Investments(R. Dorfman, ed.), Brookings Institution, pp. 277–278. Small, K.A. 2006. Urban Transportation. In Concise Encyclopedia of Economics, 2nd ed. (David R. Henderson, ed.) (forthcoming). www.econlib.org/library/CEE.html. Small, K.A., C. Winston, and C.A. Evans. 1989. Road Work: A New Highway Pricing and InvestmentPolicy. Brookings Institution, Washington, D.C. TfL. 2005. Central London Congestion Charging: Impacts Monitoring: Third Annual Report. April. TRB. 1987. Special Report 214: Designing Safer Roads: Practices for Resurfacing, Restoration, andRehabilitation. National Research Council, Washington, D.C. TRB. 1990a. Special Report 225: Truck Weight Limits: Issues and Options. National Research Council, Washington, D.C. TRB. 1990b. Special Report 227: New Trucks for Greater Productivity and Less Road Wear: An Evaluationof the Turner Proposal. National Research Council, Washington, D.C. TRB. 1994. Special Report 242: Curbing Gridlock: Peak-Period Fees to Relieve Traffic Congestion, Vol. 1. National Research Council, Washington, D.C. TRB. 1996. Special Report 246: Paying Our Way: Estimating Marginal Social Costs of FreightTransportation. National Research Council, Washington, D.C. TRB. 2002. Special Report 267: Regulation of Weights, Lengths, and Widths of Commercial Motor Vehicles. National Academies, Washington, D.C. USDOT. 1997. 1997 Federal Highway Cost Allocation Study. Aug.

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The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 USDOT. 2000. 1999 Status of the Nation’s Highways, Bridges, and Transit: Conditions and Performance:Report to Congress. USDOT. n.d. 2002 Status of the Nation’s Highways, Bridges, and Transit: Conditions and Performance:Report to Congress. Utt, R.D. 2004. Yes, Mr. President, Veto the Highway Bill. Backgrounder, No. 1725, Heritage Foundation, Feb. 13. Whitty, J.M. 2003. Road User Fee Task Force: Report to the 72nd Oregon Legislative Assembly. March. Wilkinson, M. 1994. Paying for Public Spending: Is There a Role for Earmarked Taxes? Fiscal Studies, Vol. 15, No. 4, Nov., pp. 119–135. Williams, H.C.W.L., D. Van Vliet, C. Parathira, and K.S. Kim. 2001. Highway Investment Benefits Under Alternative Pricing Regimes. Journal of Transport Economics and Policy, Vol. 35, Part 2, May, pp. 257–284. Winston, C., and C. Shirley. 1998. Alternate Route: Toward Efficient Urban Transportation. Brookings Institution Press, Washington, D.C.