March 25, 2008

Gas Taxes: When Is An 'Increase' Not An 'Increase'?

Facing the clashing realities of rising transportation costs and widespread opposition to tax increases, state governments are turning to tolls, fees, and less visible local sales taxes wherever possible. But though increasing the gas tax has been perceived as political suicide by many politicians, tinkering with this traditional centerpiece of transportation funding is worth a second look. Gas taxes are intended to charge drivers for their use of public roads, and when gas tax revenues consistently fall short of the amounts needed to maintain those roadways, increasing that tax makes great intuitive sense.

Aside from all this, in most cases raising the per-gallon gas tax can boost revenues without actually “increasing” taxes in the traditional sense. This paradox, where a “tax increase” may not actually be a “tax increase” at all, arises primarily from the odd structure of the gasoline tax. Unlike traditional percentage-based sales taxes where the tax you pay is a fixed amount of every dollar you spend (typically 5-7 cents per dollar), gas taxes are levied as a fixed amount per gallon (typically 15-35 cents per gallon at the state level).

Under a traditional sales tax, as the price of goods increase, tax revenues increase accordingly. With a 5% sales tax rate, for example, the tax owed on a $3 gallon of milk is 15 cents. If after a few years milk has increased in price to $4 as a result of inflation, the tax per gallon will rise to 20 cents. This increase in taxes paid is in essence identical to what occurs when the legislature decides to increase the per-gallon tax on gasoline, but it receives none of the negative publicity. Additionally, given that inflation increases the cost of providing public services, such tax increases are in fact a necessary component of any sustainable method of financing government.

Though this problem plagues every government relying on per-gallons gas taxes, taking a look specifically at Minnesota’s recent gas tax increase is particularly illuminating. Legislators in Minnesota who were involved in the tax increase are currently taking a lot of criticism for being “tax-first liberals” unconcerned with perceived out-of-control government spending.

Using data released by the U.S. Energy Information Administration, the 2 cent gasoline tax enacted in Minnesota in 1925 was at the time equivalent to a 9% tax (when gasoline cost 22 cents per gallon). Where does Minnesota stand today now that their tax was recently increased from 20 to 28.5 cents? This may come as a shock to some, but today’s 28.5 cent tax is still the same as a 9% rate (assuming, conservatively, that gas costs $3.07 per gallon). Without the 8.5 cent hike, the effective gas tax rate would have been only 6.5%. For some perspective, Minnesota gas taxes have been levied at effective rates of 20% or more for 13 of the past 83 years, most recently in 1988 and 1989.

A similar result can be shown by examining the effects of inflation over this time period, using data from the Consumer Price Index (CPI). Adjusted for inflation, the 2 cents collected on each gallon of gas in 1925 was the equivalent of what would be a 24.4 cent tax today. By setting the rate at 28.5 cents, what the legislature has done is little different from what inflation does to percentage-based sales taxes, though inflation of course does not have to face any of the harsh criticisms currently directed at Minnesota legislators.

Data released by the U.S. Census Bureau also suggests that Minnesota’s 8.5 cent hike may not really be a tax increase by yet another measure: as a share of consumer income. While many meaningful measures exist for measuring tax changes, what has the most meaning for consumers is tax as a percentage of personal income. Data on this measure do not extend as far back, but what is clear is that a smaller portion of Minnesotans’ budgets is going to paying the gas tax than at almost any time in the last 30 years. In 1977, 0.7% of income earned by Minnesotans went to paying the gas tax. The trend since then has been steadily downward, reaching a low of 0.3% of income in 2005. The 8.5 cent hike will certainly change this figure, though not by enough to negate the overall trend. This trend can be observed in nearly every state, and it demonstrates plainly that despite numerous per-gallon tax increases across the nation over the past few decades, gas taxes have become a less important component of taxpayers’ daily budgets and daily lives. If transportation is to continue to be adequately funded, the portion of taxpayers’ budgets devoted to its funding it will have to rise.

Summing up, it should be clear that states are justified in regularly increasing their per-gallon gas tax rates. Doing so is necessary for maintaining transportation infrastructure, and doing so should, in reality, be relatively painless since inflation is always hard at work minimizing and eventually negating the impact of such increases.


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