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Alternative Approaches to Heavy Vehicle Taxation Applications Manual - Economic Efficiency 7.0 Economic Efficiency The promotion of economic efficiency has long been one of the criteria for evaluating general tax systems. Until recently, attention to this criterion in the evaluation of highway taxes has largely been limited to academic literature. However, in the last few years, interest in applying this criterion has increased, though, even when it is used, it usually is given much less weight than the other criteria. Partly for this reason and partly because of a lack of information about the external costs: of highway use, evaluations of the economic efficiency of alternative tax systems normally are quite limited. In concept, the economic efficiency criterion can be applier! in much the same way as the equity criterion. However, to do so would require a reasonable degree of agreement on the external costs of highway use. At the present time, plausible high and low estimates of marginal external costs differ by an order of magnitude or more.2 Furthermore, a variety of practical and political problems have limited the ability of Dublin a~nci~ to implement effective charges for external costs. -A -~ rat ~ The lack of good estimates of external costs and the lack of effective means of charging for these costs limits the usefulness of comprehensive analyses of He economic efficiency of alternative systems of highway taxes. Accordingly, evaluations of economic efficiency usually are limited to analyses of the benefits and costs of a potential change in user charges that is intended to promote economic efficiency. The first section of this chapter discusses procedures for these limited evaluations of such potential tax-system changes. The second section of this chapter discusses more comprehensive evaluation procedures that ought eventually be of Interest. At the present time, we do not recommend that states attempt to apply these comprehensive procedures. However, we do recommend that states give thoughtful consideration to external costs and to economic efficiency in malting judgments about the overall merits of alternative tax systems. Consideration of the external costs and economic efficiency of tax alternatives frequently should be useful as a means of choosing between two alternatives that otherwise appear to be comparably attractive. In particular, we observe in the second section that, even without unplementing externality charges, the ability of most or ah highway tax systems to promote economic efficiency can be improved by reducing the amount of revenue obtained from fees that do not vary with VMT and increasing the amount obtained from fees (such as fuel taxes, toils and mileage-related taxes) that do vary with VMT. We use me term '`external costs" to refer to costs mat are external to bow individual highway users and highway agencies. 2 FHWA, 1997 Federal Highway Cost Allocation Study, August 1997, Tables V-22 - V-24. Cambridge Systematics, Inc. 63
Alternative Approaches to Heavy Vehicle Taxation Applications Manual- Economic Efficiency · 7.1 Evaluations of Potential Tax-System Changes The most important difference between the economic efficiency and equity goals probably is that the external costs of vehicle use are considered in the evaluation of economic efficiency but usually are excluded from the evaluation of equity. In the last few years, California and a few other states have been evaluating ways of charging for external costs. However, implementation of these charges has been slowed by difficulty in designing cost-effective forms of externality feed and by the political opposition of vehicle operators to paying for external costs. The hand of demonstra- tion projects that have been conducted to date have been limiter! to addressing issues of congestion (rather than air or noise emissions) and the charges have been applied only to relatively small numbers of vehicles using particular roads or bridges. Accordingly, evaluations of these experiments need not be very comprehensive. Rather, they need only consider whether a particular experiment contributes to economic efficiency; i.e., whether its benefits exceed its costs. An evaluation of the costs and benefits of opening a high- occupancy vehicle (HOV) lane to other vehicles willing to pay a toll, for example, requires - estimates of: 1. The value of the time saved by vehicles paying this toll; 2. 3. The value of He time saved by other vehicles as a result of decreased congestion on parallel facilities; The value of time lost by HOV occupants as a result of increased congestion on the HOV lane; A. The value of time lost on other facilities as a result of any decrease In the use of high- occupancy vehicles; and The administrative costs of the system. The benefits of Item ~ (which must be greater Man the toss paid by these vehicles4) are likely to be quite large. Also, tons are likely to be set high enough to avoid significant congestion on He HOV lane, so that the Item 3 and Item 4 costs are reasonably low; and the Item 2 benefits are also likely to be relatively small. Accordingly, evaluations of the costs and benefits of such a strategy generally focus on Items ~ and 5, usually concluding that the Item ~ benefits substantially exceed the Item 5 costs. Since no attempt is being made to design an optimum system (which might include introducing toss on some or all of He non-HOV lanes), this relatively simple evaluation is sufficient to establish the 3 Brief discussions of difficulties in administering some forms of externality fees are presented in Sections 7.3 and 7.6 of the main volume of this report. 4 The tolls paid are a transfer payment representing a cost to those that pay the toll and an equal benefit to the highway agency. Hence, toll payments drop out of a benefit/cost evaluation. 64 Cambridge Systematics, Inc.
Alternative Approaches to Heady Vehicle Taxation Applications Manual- Economic Efficiency congestion-related benefits of opening an HOV lane to other vehicles wining to pay a ton. Similar analyses generally are sufficient to Arsenate Me principal benefits and costs of other proposed forms of congestion charges. 7.2 Comprehensive Evaluations Comprehensive evaluations of the extent to which a particular highway tax system alternative promotes economic efficiency can be conducted in much We same way as equity is evaluated. For this purpose, we define an ~ciency ratio for a class of vehicles to be the sum of marginal fees paid (per vehicle-mile) by that class of vehicles divided by the corresponding marginal responsibility (per vehicle-mile) for both public agency costs and external costs. Efficiency ratios differ from equity ratios In several ways: The denominators of efficiency ratios include external costs in addition to the public agency costs used in the denominators of equity ratios; Only costs and revenues that vary with vehicle use are reflected in the efficiency ratios; Efficiency ratios reflect all marginal taxes and fees paid for vehicle operation regardless of the government to which they are paid and regardless of whether or not the revenue is used for highway purposes; and These ratios reflect aD marginal public agency costs of vehicle operation regarcIless of the government that pays these costs. In sum, efficiency ratios for a class of vehicles may be viewed as equity ratios obtained for an aB levels of government analysis that includes all external costs and user-charge revenue diverted to non-highway purposes but excludes all highway costs and user charges (such as registration fees) that do not vary with highway use. , Efficiency ratios may also be definecl for classes of travel - with separate travel classes distinguished for several vehicle classes, for two or more types of areas, and, possibly, for different time periods (e.g., peak and off-peak). Use of separate efficiency ratios for travel in different types of areas reflects We significant differences that exist between the high social costs of vehicle operation in densely populated areas and the lower costs in less populated areas. One analysis5 suggests that, on average, congestion costs in urban areas are about ten times as high as they are in rural areas and that pavement costs in the two types of areas differ by a factor of about three. Similarly, use of separate efficiency ratios for different time periods, at least in urban areas, reflects We substantial differences that exist between We congestion costs of peak and off-peak Gavel. Also, for efficiency s 1997 Federal Highway Cost Allocation Study, op. cit., Table V-26. Cambridge Systematics, back 65
Alternative Approaches to Heavy Vehicle Taxation Applications Manual - Economic Efficiency analyses, it may be desirable to distinguish vehicles on the basis of their emissions characteristics. Efficiency ratios are calculated in much the same way as equity ratios. Revenue from ah user charges that vary with vehicle use (including revenue for non-highway purposes) is obtained. This revenue can be allocated to vehicle classes using the procedures presented in Chapters 3 and 6. Alternatively, an aBocation to vehicle classes and area of operation (urban vs. rural)- can be developed by using these procedures in conjunction with VMT estimates that distinguish urban and rural VMT ant! fuel efficiency estimates that reflect the differences between urban and rural operation. These revenue avocations are compared to corresponding estimates of the marginal social costs of vehicle use. At the present time, low or midrange estimates of the latter costs obtained from the Federal Highway Cost Allocation study6 are appropriate for use. This source provides separate estimates of the marginal social costs of urban and rural operation for five vehicle classes. The economic efficiency criterion requires that ah efficiency ratios be as close to one as practical, and, at least for travel classes that compete with each other, that these ratios be reasonably similar. For any travel class, an efficiency ratio of less than one indicates that marginal user charges paid by vehicles operating in that class cover only a fraction of the marginal social costs of their operations. (The efficiency ratio represents an estimate of the average size of this fraction.) For some of these operations, marginal social costs may exceed user benefits - reflecting econom~caDy inefficient uses of the highway system. To the extent that operations in two different travel classes compete with each other, any difference in the efficiency ratio for the two classes represents an incentive to overuse operations in the class with the lower ratio and to underuse operations In the over class. This principle extends to competition between classes of highway travel and non- highway travel. Thus if railroads clo not pay for Me external costs of their operations, it may be undesirable for combination trucks (or for Me rail~ompetitive subset of these trucks) to pay for Weir full external costs.7 Under erasing tax systems, average efficiency ratios are much less than one for ah or virtually ad vehicle classes and travel classes. Two potential means of increasing all efficiency ratios are: · Reducing Me amount of highway revenue obtained from charges Mat do not vary win VMT (e.g., registration fees) and increasing Me amount obtained from charges Mat do vary wad VMT (e.g., fuel taxes, totes and mileage-related taxes); and · Decreasing Me amount of non-highway revenue obtained from highway fuel taxes and over VMl-related taxes - a 50 cents per gallon tax on highway fuel produces a 6 Ibid, Tables V-22 - V-24 and V-26. 7 A footnote in Section 2.4 concludes that ideally, to avoid encouraging inappropriate modal diversion, rail-competitive trucks should be charged for Weir marginal public-sector infra- structure costs plus the estimated net difference (per ton-mile) between me external costs of rail- competitive truck operations and pose of truck-competitive rail operations. 66 Cambridge Systematics, Inc.
Alternative Approaches to Heavy Vehicle Taxation Applications Manual - Economic Efficiency charge Mat approximates one estimate of We average extent costs of operating an automobile on the rural Interstate system.8 Both of these possible changes in tax systems are reasonably simple from an administrative standpoint, though proposals for the second type of change have encountered substantial political opposition. For the latter type of change to be politically feasible, it probably would have to be coupled with a comparable decrease In the personal income tax or some similar tax. Other means of improving the economic efficiency of highway tax systems Include various proposals for congestion fees and emissions fees, some of which are discussed in Chapter 7 of the main volume of this report. The external costs of operating an automobile on the rural Interstate system are estimated to average 1.8 cents per mile exclusive of air pollution costs (Federal Highway Cost Allocation Study, op. cit., Table V-26) - approximately equal to Me cost of a 50 cents per gallon fuel tax for a 28 mpg automobile. The corresponding costs for operating an automobile on the urban Interstate system are estimated to average 9.1 cents per mile, and the costs for operating various types of trucks are estimated to be several times as high. Cambridge Systematics, inc. 67
Alternative Approaches to Heady Vehicle Taxation Applications Manual- Economic Efficiency 68 Cambridge Systematics, Inc.
