PAYING TO GET FROM HERE TO THERE: Meeting North Carolina’s Transportation Revenue Needs in Difficult Times

PAYING TO GET THERE FROM HERE
Meeting North Carolina’s Transportation Needs in Difficult Times
STEVE JACKSON, PUBLIC POLICY ANALYST

Executive Summary
North Carolina’s transportation budget is in crisis. Revenue from the state’s main
source of transportation revenue, the gas tax, has lagged far behind construction
inflation, thanks to more fuel-efficient vehicles, fluctuating gas prices and the
recession, which has prompted many people to drive less.

The recession has also caused a decrease in vehicle sales, and as a result receipts
from the Highway Use Tax, the state’s sales tax on vehicles, are expected to be
down over twenty percent in 2008-09 compared to the previous fiscal year.
The third major piece of North Carolina’s transportation revenue system, vehicle
registration fees, fails to take into account the damage heavier passenger vehicles
do to the state’s roads, and as a result drivers of lighter cars are forced to help cover
the costs of damage done by heavier cars.

Changing to a system that more directly taxes road use – based on the number
of miles a vehicle travels – would be beneficial to revenue collections and could be
designed to more fairly distribute tax responsibility. However, creating such a
system is currently unrealistic because of administrative and technology hurdles.

Instead, North Carolina must take a close look at its current transportation revenue
sources in order to make them more efficient and effective. First, it should remove the
cap on the variable portion of the gas tax. North Carolina will miss out on $250 million
in transportation revenue in the first six months of this year because of the cap.
North Carolina should also abolish the Highway Use Tax’s trade-in exemption,
which is nothing more than a subsidy for auto retailers, and increase the rate of
the HUT by a modest one percent. Together, these changes would add an
additional $300 million to the state’s transportation coffers.

Revising the structure of our registration fees system to reflect the damage heavier
vehicles inflict on roads would increase transportation revenues by upwards of
$150 million per year.

Dedicating one-third of the new revenue created by these proposals would be
sufficient to substantially fund a new state Intermodal Fund that could provide
grants to local governments and entities for capital works in public transportation,
ports, rail and bike and pedestrian facilities.

The fee increases recommended should be offset by an increase in the Earned
Income Tax Credit for low-income households of 2% total, providing average relief
of $32 to eligible households at a cost of around $27 million per year. This cost
could be funded directly by the fee increases.

OVERVIEW

North Carolina’s transportation system is straining under the combined pressure of
aging infrastructure, growing demand and decades of poor administration. In her
first week in office, Governor Beverly Perdue took aim at the administrative problems
by committing to reform of the Department of Transportation and its board. Hopefully,
changes in leadership and a restructuring of the makeup and responsibilities of the
Board of Transportation will lead to a decision-making process based on needs instead
of political considerations.

While these reforms should result in more efficient spending, the state still faces a
considerable shortage of dollars designated for transportation because the funding sources
are not keeping pace with the state’s needs or rising construction costs. Revenues from the
gas tax and the vehicle sales tax have declined thanks to the recession and the increase in
popularity of smaller, more fuel-efficient cars. In addition, vehicle registration fees have
never adequately reflected the damage larger vehicles inflict on the state’s roads.

This report examines the current status of the state’s three primary sources of
transportation revenue and recommends changes. However, because transportation taxes
tend to more heavily impact low-income people and because of the current recession,
prudence and balance demand a modest approach that ensures the tax base (who gets
taxed) is appropriate, does not emphasize raising tax rates, and provides a tax break for
low-income families to offset any increased costs.

North Carolina’s transportation needs would be best served by changing to a system that
taxes drivers based on the number of in-state miles their vehicles travel. However, there are
several administrative and technical hurdles that make such a switch impossible at this
time. In the short term, North Carolina should remove the cap on its gas tax, rework its
tag fees structure, close a major vehicle sales tax loophole and slightly increase the vehicle
sales tax rate. These changes would raise substantial new revenues in a fair manner and
enable North Carolina to begin to address its transportation challenges.

Troubles with the Gas Tax and the Highway Use Tax
 

North Carolina’s three main sources of transportation revenue are the gas tax, the Highway Use Tax (HUT) on vehicle sales, and vehicle registration fees. The gas tax provides more than half of the state’s transportation revenue. Three-quarters of that money goes into the Highway Fund for road maintenance, public transportation and ports and airports, while the remaining quarter goes to the Highway Trust Fund to help fund the building of new roads. As cars have become more fuel-efficient over the decades, the rate of the gas tax has failed to adjust. In 1963, the average driver paid three times more in gas taxes to drive one mile than he does today. Recent data illustrate the accelerating trend to more fuel-efficient vehicles: the number of taxable gallons sold between 2003-04 and 2006-07
increased less than 2 percent, while North Carolina’s population increased more than
6 percent. In addition, the spike in gas prices in 2008 led to a historic decline in
vehicle-miles traveled - down 7.1 percent in August 2008 from one year before in
North Carolina. Gas tax receipts will be down over 5 percent for 2008-2009. The
uncertain economic outlook does not bode well for gas tax revenues over the next two
or three years.

The crisis of the gas tax has been building for many years, but it has now been joined
by a downturn in receipts from the Highway Use Tax, the state’s sales tax on vehicles.
The HUT makes up about one-fifth of state transportation revenue and is used to fund
road construction. HUT receipts are expected to be down more than twenty percent,
in 2008-09 compared to 2007-08.6 The recent economic downturn and higher gas
prices have pushed overall demand for vehicles down and switched some remaining
demand toward lower-priced vehicles.

As these major revenue sources run into trouble, the price of transportation
infrastructure construction and maintenance has rapidly increased. The cost of highway
and street construction materials increased 43 percent between July 2003 and July
2007.7 Construction material costs rose by more than 20 percent in the first nine
months of 2008 alone.

TRANSPORTATION TAX IS REGRESSIVE

State transportation taxation is broadly based on user-fee principles. The system is
regressive because the taxation or fee rates do not vary with income and as a
result low-income people pay greater shares of their incomes toward these taxes than
upper-income people do.

Transportation taxes are particularly concerning because they are largely unavoidable
for working families. Access to mobility is vital for work and social connectivity. There
is only a small degree to which households can avoid the gas tax and HUT beyond
which lies effective exclusion and diminished economic and social opportunities.

Studies from the last twenty years have found the gas tax is among the most regressive
forms of transportation funding,9 and the emergence of hybrid vehicles and more fuelefficient
vehicles has exacerbated that situation. Households that can afford these vehicles
effectively shift some of the costs caused by their driving to households that drive older
and/or less fuel-efficient vehicles. Every new hybrid vehicle on the road -- until cheaper
models or a large second-hand market emerges -- further shifts those costs.
The gas tax is a finance mechanism that is unable to adjust for this shift, and therefore
at some point in the future, an alternative must be found.

Since progressive forms of taxation, such as income taxes, are extremely unlikely to be
used to fund transportation, selecting the best revenue source must be based on
minimizing regressitivity and ensuring the tax base includes all users. Taxing road use
more directly -- i.e. by taxing vehicle-miles traveled (VMT) -- looks like the best longterm
candidate, if commercial trucking is included. VMT taxes are certainly regressive
and unavoidable, yet they are more equitable than most non-use taxation forms
dedicated to transportation, such as sales taxes.

The practical question arises as to whether it is possible to adopt a VMT tax approach
now, and to do so while the gas tax remains the major revenue source. This seems
unlikely because of two considerable obstacles.

First, the state must find a reliable way to measure vehicle-miles traveled. VMT
measurement systems using global positioning systems are still experimental, and
using simple annual odometer readings to measure miles traveled creates the problem
of how to deal with out-of-state travel of residents and in-state travel of non-residents.
Second, the question arises as to how to phase in a VMT system while phasing out
the gas tax. Simply adding it to the existing gas tax undermines whatever equity
credibility it may have – it becomes a second user charge.

Moving to a VMT approach will probably require either federal, multi-state or large state
(i.e., California) initiative to introduce the technology and solve in-state and out-of-state
issues. It is a matter of judgment, but if the choice is either raising the gas tax or adding a
VMT tax, then, at present at least, staying with the gas tax is more attractive.

REGISTRATION FEES ISSUES

Vehicle registration fees (tag or plate fees) in North Carolina are predominantly a flat rate,
although larger non-commercial light trucks (over 4000 pounds) do have higher tag fees.
The flat-rate fee structure means drivers of non-commercial lighter vehicles (small
sedans and compacts) are subsidizing the repair of road damage caused by noncommercial
light-truck vehicles (SUVs and pick-ups). The structure of tag fees should
be changed to better reflect the relative degree of damage each vehicle does to the
road, which is an issue of weight.

Fees for commercial trucks, especially those towing large trailers, do not reflect the
damage they do to roads. The commercial trucking business is transferring the cost of
the damage caused by their trucks to non-commercial drivers. This will need
addressing in future years.

RECOMMENDED REFORM

Some politically feasible tweaking of rates, closing of loopholes and restructuring of
vehicle registration fees could have a profound effect on transportation revenue,
raising new revenue in excess of $400 million per year.

A recent Brookings report concluded that, despite its growing problems, raising the gas
tax may be a better bet right now than introducing a VMT tax.11 This conclusion is
based on the fact that the country is currently seeing an historic decline in vehicle-miles
traveled; gas prices and a bad economy are reducing driving.

The cap on the gas tax has cost and will cost the transportation budget hundreds of
millions of dollars. For instance, absent a cap, the tax would be at 40 cents per gallon
from January 1 to June 30 of this year (a rate based on wholesale prices from April
through September 2008, before gas prices tumbled). Instead it will remain at the
cap of 29.9 cents, a loss of at least $250 million in just six months.
Given the importance of the gas tax to the budgets for maintenance, public
transportation, ports and bike and pedestrian projects, there is a reasonably
compelling argument that the cap be lifted. Of course, lower gas prices in the first
half of 2009 will mean lifting the cap will have no effect on collections in the short
term, but there will be the promise of future greater revenue collections once gas
prices again reach the four dollar per gallon mark.

For all the problems with sales taxes, the Highway Use Tax is nevertheless a critical
contributor to transportation revenue and is the major state funding source for highway
construction. The danger lies in the urge to significantly increase the rate and fall into
over-reliance, which would potentially depress vehicle sales and hurt low-income people.
The HUT is presently set at 3 percent, compared to the standard rate on goods of
6.75 percent. North Carolina’s HUT is lower than surrounding states, save South
Carolina. A one-percent increase would be modest and would yield around $170
million, a sum that would increase as the economy improves.

The trade-in exemption to the HUT is a subsidy to auto retailers that North Carolina can
no longer afford. That exemption means a buyer trading in a vehicle to an auto retailer
pays 3 percent on the new vehicle price less the trade-in value. While many states in the Southeast have this “net of trade” loophole, their HUT rates are higher: Georgia’s varies
from 4 percent to 7 percent depending on the county. Tennessee’s is 7 percent. Virginia
has a 3 percent vehicle sales tax but no trade-in exemption. Florida has a 6 percent tax
with no trade-in exemption.
Abolishing the trade-in exemption would generate around $100 million per year with
the HUT at 3 percent, upwards of $130 million per year if the HUT moves to 4
percent. Again, that sum will increase as the economy improves.

Since registration fees fund road maintenance, it is logical that the structure of the
registration fee schedule reflect the relative wear-and-tear a vehicle imposes on roads. Heavier
vehicles inflict more wear-and-tear on roads, and therefore it would be reasonable for fees to
increase proportionate to the weight of the vehicle, as they do in Florida, Virginia, Maryland
and Texas. Furthermore, larger light trucks and SUVs should be charged more than cars of
similar weight because they are built to carry greater loads.

The current fee schedule charges more for heavier light trucks but makes no differentiation
among cars. The current fee for all cars and light trucks (i.e. SUVs and pick-ups) weighing
less than 4000 pounds (curb weight plus driver) is $28, except in the Triangle counties,
where it is $33. This flat fee is about average for the region, except for in Virginia, where
fees are 35 percent higher for vehicles less than 4000 pounds.

Given that North Carolina maintains more lane miles than every other state save Texas,
and that its roads and bridges are generally acknowledged to be in a poor state of repair,
the argument that registration fees are too low and that the maintenance budget is
suffering as a result is compelling. The bottom passenger-vehicle rate should be at least
equal to Virginia’s ($38.75), and rates for heavier vehicles should be adjusted accordingly.
Based on a fee increase of $10 for compact vehicles, a hypothetical new schedule could be
structured as follows: [See PDF for table]

These fee increases in the $20 to $25 range on vehicles over 3000 pounds would increase
registration fee revenues by upwards of $150 million in the first year.

State road construction is largely funded via the Highway Trust Fund. A parallel state fund
specifically for intermodal projects (public transportation, bike and pedestrian improvements,
rail freight and ports) has been recommended by the 21st Century Transportation
Committee, the study commission of legislators and citizens that reports to the NC General
Assembly. This fund would make grants to local governments and transportation entities.
Filling this new state fund would probably cost around $160 million (in 2007 dollars) per
year through 2020, based on assessments of needs by the Intermodal Committee of the
21st Century Transportation Committee. The immediate needs would be less, starting at
$100 million per year in 2009-10. Dedicating one-third of the new revenues proposed
above could be the revenue basis of this new fund.

The justification for using road-based charges and taxes for non-road transportation
improvements is simple and obvious: road users benefit from the development of
transportation alternatives because they reduce traffic on roads by providing a viable
alternative to driving.

Any fee increases should be offset by an increase in the state Earned Income Tax Credit
(EITC) to hold harmless low-income households. Assuming an average increase of
around $25 for each vehicle registration, the required EITC increase would be around
1.5 percent for an average benefit of $24, which would cost the state approximately
$20 million annually.

The Highway Use Tax increase could also be offset by a 0.5 percent increase in the
EITC, costing a little under $7 million annually. The average benefit of $8 per
household would go some way to offset the HUT increase on purchases of inexpensive
vehicles, assuming that such vehicles are driven by purchasers for multiple years.

CONCLUSION

The tax and fee increases recommended in this report are relatively modest,
reflecting the difficult economic times and the pressing need to stretch our
transportation tax dollar further by introducing a more stringent project selection and
prioritization process that better considers the effect of projects on future
transportation demand and land use patterns. But more money is needed at the state level, not the least for non-highway projects, in particular for public transportation.

The changes are contingent on the allocation of a third of the new revenue to a new
state Intermodal Fund, and to an EITC offset to ease the burden these fee increases
would impose on low-income people. From a practical perspective, a more balanced
approach to transportation requires increased revenue streams. The package
recommended here is a starting point for that goal.