The Fuel Tax and Alternatives for Transportation Funding: Special Report 285 (2006)

Highway¹ programs derive most of their funding from user fees, which are special taxes and charges incurred by vehicle operators in relation to their use of roads. Governments dedicate most highway user fee revenue to highway spending ($85 billion out of $107 billion collected in 2004) and also devote a share to transit ($11 billion in 2004). Fuel taxes generate most highway user fee revenue (64 percent of the total in 2004); other user fee revenues are from vehicle registration fees, excise taxes on truck sales, and tolls.

This study assesses the revenue-generating prospects of fuel taxes and other user fees and identifies alternatives to the present finance arrangement. Transportation officials have been concerned that the sources that provided stable and growing revenue for their programs for many decades could become unreliable in the future. They see two possible threats to the viability of the established arrangement: that fuel consumption and fuel tax revenue could be depressed by changes in automotive technology, rising fuel prices, or new energy or environmental regulations; and that the user fee finance principle that has been the basis of highway finance may be eroding in practice, as nonhighway applications of user fee revenues proliferate and dependence on revenue from sources other than user fees grows. The vulnerability of excise tax revenue to inflation in an era when tax rate increases often seem politically infeasible magnifies these concerns.

In judging the merits of the present finance system and alternatives, the Transportation Research Board study committee focused on how finance arrangements affect the performance of the transportation system by influencing the decisions of travelers and government investment and management decisions. This

criterion led the committee to give special attention to methods of charging fees that could be directly related to the cost of providing services—in particular, tolls and mileage charges.

The committee did not estimate how much governments should spend on transportation and did not interpret its task as devising revenue mechanisms to support an increased level of spending. There is no certainty that finance reform in the direction of improving the efficiency of transportation would increase revenues. A reformed finance system would remain subject to many of the external political and economic constraints that limit the revenue potential of the present system. However, reform would help transportation agencies to manage capacity and to target investment to projects with the greatest benefit to the public. Each dollar spent would be more effective and services would improve, and it is conceivable that the public would be willing to pay more for transportation programs that worked better.

The committee’s conclusions concern the two parts of its charge: to assess threats to the viability of the present finance system and to identify directions for reform of transportation finance.

The risk is not great that the challenges evident today will prevent the highwayfinance system from maintaining its historical performance over the next 15 years; that is, it should be able to fund growth in capacity and some service improvements, although not at a rate that will reduce overall congestion.

A reduction of 20 percent in average fuel consumption per vehicle mile is possible by 2025 if fuel economy improvement is driven by regulation or sustained fuel price increases. Offsetting the revenue effect of such a gain would not require unprecedented increases in fuel tax rates. The willingness of legislatures to enact increases may be in question, but the existing revenue sources will retain the capacity to fund transportation programs at historical levels.

Without new regulations, fuel price increases alone probably will stimulate only a small improvement in fuel economy in this period.

Three factors will constrain the rate of progress on fuel economy: first, consumers prefer to maintain or enhance the performance and size of the vehicles they buy; second, new vehicles that offer performance and cost close to those of

today’s vehicles with significantly lower fuel consumption will require time to be brought into large-scale production; and finally, the stock of vehicles on the road turns over slowly. Energy forecasts are speculative; however, there are grounds for expecting that, although the relatively high prices of 2004–2005 may persist, output will increase sufficiently to moderate the long-term price trend. Supplies are available from multiple sources that can be developed and brought to market at lower cost than the 2005 price, and maintaining the price of oil at too high a level is not in the long-term interest of the major producers because it encourages conservation and stimulates development of alternative sources.

Government transportation finance practices have been remarkably stable and resilient since the creation of the present federal highway program in 1956. However, some potential sources of stress are evident, particularly in certain states where the local share of responsibility is high. These include pressures to expand use of highway user fee revenue for nonhighway purposes, the growth of transit spending as a share of local transportation spending, and the vulnerability of revenues to acceleration of inflation.

The finance system has contributed to the success of the highway program in delivering a positive return on the national investment in highways because fees modestly discourage motorists from making trips of little value, spending is limited by the revenues generated from users, and motorists can see the cost of providing roads in the fuel taxes and registration fees they pay. However, highway programs have important failings related to finance. The system does not provide a strong check that individual projects are economically justified. Congestion and pavement costs are tolerated that could be avoided if motorists were charged prices that more closely matched the cost of their use of roads.

Although the present highway finance system can remain viable for some time, travelers and the public would benefit greatly from a transition to a fee structure thatmore directly charged vehicle operators for their actual use of roads. The growing cost of maintaining acceptable service under present funding and pricing practices may at some point compel reforms that would increase efficiency. The transition could proceed in stages, starting with closer matching of present fees to costs and expanded use of tolling. Ultimately, in the fee system that would provide the greatest public benefit, charges would depend on mileage, road and

vehicle characteristics, and traffic conditions, and they would be set to reflect the cost of each trip to the highway agency and the public.

The potential benefits of a transition to direct charging are improved operation of the road system and better targeting of investment to the most valuable projects. Revenues from charges set to reflect the cost of providing service would provide an accurate indication of where capacity expansions would have benefit. Governments that own and operate roads could control fees and funding, so dependence on intergovernmental aid would be reduced. Reform in this direction offers the best opportunity for increasing the cost-effectiveness of spending and mitigating congestion.

The committee identified two complementary tracks for practical reform:

• Toll roads and toll lanes: An important opportunity exists today to create an extensive system of tolled expressways and expressway lanes employing existing electronic toll collection technology and variable pricing. Although such a toll program probably would not greatly increase the funds available for highways, it could expedite construction of critical highway improvements, provide a tool for managing congestion, and help gain public acceptance of road pricing.

• Road use metering and mileage charging: This appears to be the most promising technique for directly assessing road users for the costs of individual trips within a comprehensive fee scheme that will generate revenue to cover the costs of highway programs. It uses communications and information technology to assess charges according to miles traveled, roads used, and other conditions related to the cost of service. Unlike conventional tolling, which is applicable only on expressways, road use metering could be used to manage and provide funding for all roads. Conversion to road use metering will require a sustained national effort. Governments must decide on the goals of the effort, authorities for setting fees and controlling revenue, the basis for determining fees, and how best to involve the private sector. Resolution of privacy and fairness concerns will be a prerequisite.

As the finance system evolves, governments can keep it on a course leading to the necessary improvements by adhering to the following rules:

• Maintain the practice of user fee finance, a system in which users of facilities are charged fees or special taxes, rates reflect the costs to serve each user, and expenditures equal the fee revenue.

• Seek opportunities where possible to apply pricing—that is, allow fees to ration access to facilities.

• Align responsibilities so that local governments provide facilities that serve mainly local travel, states serve regional traffic, and the federal government

retains only functions that it can perform more effectively than state and local governments. Governments must control the resources required to carry out these functions; therefore a goal of reform should be to allow each jurisdiction to collect fees from all users of its facilities.

• Give full consideration to the environmental and equity consequences of reform. Fundamental finance reform that aligned fees more closely with costs would eventually have profound effects on the locations of households and industries. The overall economic and environmental impacts of reform would be positive, but some individuals and communities would suffer harm if no provisions were made for compensation.

The committee proposes immediate changes to strengthen the existing highway and transit finance system and actions to prepare the way for fundamental reform.

Because superior alternatives will require time to develop, the nation must continue to rely on the present framework of transportation funding for at least the next decade. Therefore, governments must take every opportunity to reinforce the proven features of the present system, in particular, user fee finance in the highway program. The following actions would help to maintain the effectiveness of the overall system:

• The federal government and the states should make adjustments to user fee rates (for example, adjustments in registration and permit fees to better align payments with cost responsibilities) that would provide incentives for more cost-conscious use of highways by operators of large trucks and other vehicles.

• Congress and the states should consider eliminating fuel tax exemptions that are commonly abused and take other measures to reduce losses to tax evasion.

• The states should make provision for advanced-technology vehicles in the user fee structure so that operators of these vehicles contribute to the upkeep of highways on a basis similar to that of other users. In particular, future vehicles that consume fuels not currently taxed should contribute on some basis, and incentives to promote conservation technologies should be designed so that they reasonably apportion the cost burden of the promotion among road users and the public and do not encourage inefficient use of roads.

• Regardless of the overall scope of the federal surface transportation program in the future, the federal government should retain certain core responsibilities, including aid to ensure that the states to not underinvest in routes of national significance, the setting of standards, environmental regulation and enforcement, and research and development.

The federal government should encourage states to experiment with arrangements for tolling and private-sector participation in road development. To this end, states should be allowed to impose tolls on existing roads that were built with federal aid, and they should be allowed flexibility in the design of toll systems.

The states and the federal government should undertake serious exploration of the potential of road use metering and mileage charging. Creation of a structure to support individual states that decide to conduct trials or pilot implementations may be the most practical initial arrangement. However, a program with national focus will be required, with federal leadership and funding aid for research and testing.

The first requirement will be technical trials to evaluate the reliability, flexibility, cost, security, and enforceability of alternative designs and to gain information on proper administration of these systems and user acceptance. Once technically proven designs are available, the federal government should support one or more trial implementations that would be on a large scale and fully functional but that would be limited in scope with respect to the region, roads, or vehicles involved. The participating states would require federal technical coordination and financial aid. Evaluation must be integral to the design of trials and must be provided for in schedules and budgets. Designs and pilot implementations should be compatible with the principle that each state and local jurisdiction should control charges on and revenues generated by the roads it owns.

Reforms of highway finance arrangements in the future will give rise to needs for reviewing and adjusting the relationship of highway and transit funding. The following are guidelines that should be considered:

• Transit systems at present require dedicated, broad-based tax support. Developing such support will be necessary in order to maintain and expand transit services.

• Greatly increasing transfers of highway user fee revenues to fund expanded transit services would risk a loss of travel benefits through declining highway performance that could be greater than the transit benefits gained. This risk imposes a limit on the potential of existing highway user fees as a source of transit funding.

• Federal and state transportation aid should be provided for the purpose of relieving local governments of the burden of serving nonlocal needs rather than subsidizing local services.

• Road pricing instituted in metropolitan areas should be used to increase transit’s financial self-sufficiency by eliminating subsidies to highway travel, giving transit the market power to increase fare revenue, and improving bus service quality.

Transportation agencies must develop new capabilities for research, evaluation, and communication with the public in order to manage finance reform successfully over the next few decades. If tolls and mileage charges become important sources of highway funding, agencies will be faced with fundamentally new kinds of management decisions and information requirements. At the same time, the effects of the new charges will provide information never before available about the value of highway facilities. To develop the capability to fulfill the new management and information requirements, an organized program will be necessary. The institutional structure of the program must provide for a joint federal–state effort, guarantee that scientific evaluations of alternatives are carried out, and build public confidence through open processes.

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