Why sales taxes and gasoline don’t mix
By Michael Madowitz and Kevin Novan,
Virginia’s quest to raise revenue for transportation without raising its gas tax has entered yet another bizarre phase. Gov. Robert F. McDonnell’s original plan to eliminate the state’s portion of the gas tax and increase the sales tax by 16 percent was badly flawed. We’re sorry to report that the compromise approach that passed the General Assembly on Saturday may be even worse.
The legislature’s plan will convert Virginia’s gas tax of 17.5 cents per gallon to a 3.5 percent tax on gas (and 6 percent on diesel fuel) at the wholesale level. The idea is touted as creating a revenue stream that will rise with inflation and keep up with Virginia’s transportation needs. As a fringe benefit, it will also relieve Virginia politicians of the task of raising gas taxes.
But the slow-and-steady revenue increase envisioned will occur only if gas prices track inflation closely — which historically they have not. In the real world, such a sales tax will make prices at the pump, already prone to sharp fluctuations, even more volatile while at the same time making transportation funding less reliable. When oil prices fall, a sales tax will leave the state without enough money for new roads and maintenance. When events abroad cause prices to spike, the commonwealth’s tax on gas will shoot up as well. This will indeed produce more revenue, but it will also exacerbate the pain for motorists at a moment when additional pain may be the last thing the broader economy needs.
We have studied this tax structure in some detail in California, which until recently, imposed an 8.25 percent sales tax on gas. The results were straightforward. During one six-month period, drivers paid a sales tax ranging from 13.2 cents per gallon (when gas was $1.82) to 32.5 cents per gallon (when prices peaked at $4.48). It’s bad enough that gas price spikes leave drivers with less disposable income. It adds insult to injury for the state to automatically increase its per-gallon tax at the same time.
The effect on transportation funding can be even more dramatic. Over the past decade, California generated about $6 billion per year from gas taxes. Roughly half of this came from a fixed tax of 18 cents per gallon while the other half came from the sales tax. Over that time, the revenue from the flat, per-gallon tax fluctuated by about 1.2 percent from one year to the next. In contrast, the revenue generated by the gas sales tax fluctuated by an average of 13.5 percent.
Generating a predictable stream of revenue is extremely important for funding transportation plans that can extend many years into the future. Given that it is far easier to predict gas consumption than prices, it is prudent to tie transportation revenue to consumption.
It’s easy to beat up on today’s policymakers for raising taxes, but the true fault here lies with 25 years of Virginia leaders who watched inflation eat away at the value of the gas tax and did nothing. Virginia would be best served by an approach that asks people to pay for what they use, assumes inflation will occur and accepts that transportation infrastructure costs money. To do that, all that was needed was indexing the per-gallon gas tax to inflation.
Michael Madowitz is a doctoral candidate in economics at the University of California at San Diego. Kevin Novan is an assistant professor of agriculture and resource economics at the University of California at Davis.
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