Virginia has a novel plan to replace the gas tax — but there’s a hitch

February 25, 2013

Politicians have a love-hate relationship with the gas tax. On the one hand, it's a simple way to provide funds for roads and bridges — paid for by drivers. On the other hand, the per-gallon tax often fails to keep up with inflation, and lawmakers are loath to raise it.


Over the past month, lawmakers in Virginia have devised a novel way around the latter problem. The General Assembly's new transportation bill would eliminate the state's existing tax at the pump, worth 17.5 cents per gallon, and replace it with an array of sales taxes. Wholesale gasoline would now be taxed at 3.5 percent. Diesel fuel would be taxed at 6 percent. The levy on car sales would be raised from 3 percent to 4.3 percent. There's a new $100 tax for hybrids and electric vehicles. And the general sales tax would be bumped from 5 percent to 5.3 percent.

What's the point of this? Since the new taxes are structured as a percentage of sales rather than as a flat fee, revenues are expected to rise over time and keep up with inflation. That should spare Virginia lawmakers the pain of having to raise gas taxes again to pay for roads and bridges. And, since the tax is diversified, it's expected to bring in revenue even if drivers continue buying more fuel-efficient cars and using less gasoline.

But there's also a potential flaw here. As economists Michael Madowitz of UC San Diego and Kevin Novan of UC Davis point out, the new sales tax on gasoline and diesel could prove much more volatile than the old system. When the price of oil rises, the gas and diesel taxes will rise too, exacerbating the pain of oil spikes. On the flip side: If oil prices fall, then the tax also shrinks, causing revenues to drop. (Update: Though the Virginia bill does set a floor — namely, the average wholesale gas and diesel price on Feb. 22, 2013.)

Is this a realistic concern? If history is any guide, yes. The two economists recently wrote a paper (pdf) looking at California, which had a 8.25 percent sales tax on gasoline until 2010. Revenues from the sales tax fluctuated sharply over the past decade as oil prices wobbled — moving 13.5 percent on average from one year to the next. By contrast, revenues from California's flat 18-cents-per-gallon tax at the pump stayed relatively stable, fluctuating an average of just 1.2 percent.

"Generating a predictable stream of revenue is extremely important for funding transportation plans that can extend many years into the future," the economists write. A sales tax on gasoline and diesel isn't ideal for that, especially in a world where oil markets seem to be getting increasingly volatile.

So what's the alternative? Madowitz and Novan argue that Virginia's legislature should have just kept the existing tax on gasoline and indexed it to inflation. That's certainly simpler, and it avoids the volatility problem.

Yet it's worth noting that even an inflation-indexed gas tax comes with its own drawbacks. For one, Americans are now buying more fuel-efficient cars and trucks. That means shrinking revenues for roads and bridges that need repair. Virginia, as noted, is trying to surmount this second hurdle by diversifying its tax base and imposing fees on electric cars. Other states, by contrast, have looked into ideas like a tax on miles-traveled. So far, no state has quite figured out the best response here.

* Update: Added note that there's a floor on the wholesale gas tax.

Further reading:

-- Stewart Schwartz has a longer, more critical breakdown of Virginia's transportation bill at Greater Greater Washington. Among other things, he notes that the bill will shift part of the burden for roads onto non-drivers, thanks to a hike in sales taxes. (You could argue that non-drivers benefit from roads too, but this is a shift in the longstanding "user pays" principle.) Schwartz also delves into the question of where the money will go, worrying that much of the funds will be spent "on unnecessary highway projects."

--A look at efforts by states like Oregon to replace the gas tax with a vehicle-miles-traveled tax.

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