CRS RELEASES BRIEF ON IMPACTS OF GASOLINE TAX.

SUMMARY

Increases in the Federal excise taxes on gasoline and other motor fuels are of interest to Congress as a way of achieving various policy objectives: reducing Federal budget deficits, making the air cleaner, reducing energy use and dependence upon imported oil, and financing highway construction. The Clinton Administration considered raising those taxes, opted instead for a so-called Btu tax -- a broadly-based energy tax based upon the heat content of fuels -- but now has accepted a tax on transportation fuels (only).

The issue is whether Congress should raise motor fuel excise taxes for one or more of the above purposes.

Federal excise taxes on gasoline and on diesel fuel used for highway driving are 14.1 cents and 20.1 cents per gallon, respectively. Gasohol receives an exemption of 3.08 cents to 5.4 cents per gallon, depending upon the fraction of alcohol in the mixture. The gasoline tax generally is collected from terminal operators as it is removed. All sales of gasoline to final users include the tax; tax-exempt users must file for a refund. The diesel tax generally is collected from wholesalers; tax-exempt sales of diesel are permitted for off-highway uses and certain non-taxable entities. Revenues from the gasoline and diesel fuel taxes are allocated mostly into the Highway Trust Fund for roads, bridges, and mass transit. Half of the 5-cents-per-gallon increase in the taxes enacted in 1990 is designated for deficit reduction.

CRS estimates that GROSS annual revenues from the Federal excise taxes rise by $1.2 to $1.3 billion for each 1-cents-per-gallon increase over present tax levels, depending on the amount of tax increase and how long it has been in effect. A collection and administrative system already is in place. However, macroeconomic simulations of a 30-cent tax boost indicate that the net deficit reduction would be only about two-thirds of the rise in gross revenues, due to declines in revenues and increases in Federal expenditures sensitive to economic activity.

It can be assumed that nearly all, if not all, of the reduction in motor fuel use caused by a tax increase would be translated into lower imports of oil and, therefore result in an improved trade balance and reduced vulnerability, at least in physical terms, to future cutoffs of foreign oil supplies. A motor fuel excise tax boost has a smaller effect on output and the general price level than an oil import tax.

Other economic effects, however, are mixed or negative. Opponents say that reduced use of motor fuels combined with lower prices (excluding the tax) to sellers would adversely affect U.S. petroleum refiners and marketers, and probably also the automobile and related service industries. However, other sectors would benefit somewhat from increases in outlays on less petroleum-intensive activities. The macroeconomic ramifications are complex and largely negative according to many. But a CRS econometric analysis, using the DRI/-McGraw-Hill (DRI) model, indicates that the adverse macroeconomic effects of a 30-cents-per-gallon increase phased in evenly over 3 years would be relatively small.

Residents of small, urbanized States would be less affected than residents of large, rural States; the latter drive more. Opponents claim that an increase in motor fuels taxes tends to be regressive, imposing a relatively greater burden on the poor than on the rich. Recent research, however, suggests that motor fuels excise taxes (or increases in them) may not be as regressive as widely believed.

MOST RECENT DEVELOPMENTS

At the beginning of 1993, support for a boost in motor fuel excise taxes broadened in the Congress, academic and think-tank circles, and some major industries; and an increase initially was considered by the Clinton Administration to be part of its deficit reduction package. The new Administration opted instead for the Btu tax; and the budget reconciliation bill passed by the House of Representatives on May 27 included a modified version of that tax.

Objections to various parts of the Btu tax proposal had spread widely by late May, however, with an increase in the motor fuel taxes appearing to become more acceptable. And the Senate's bill, passed on June 16, included a transportation fuels tax of 4.3 cents per gallon, applying to most non-highway as well as highway uses. The conference committee's compromise version, passed by the House and Senate on August 5 and 6, respectively, essentially adopted the Senate's 4.3 cents per gallon transportation fuels tax, which becomes effective Oct. 1, 1993.

BACKGROUND AND ANALYSIS

The Federal excise tax on gasoline was first enacted in 1932; the tax on diesel fuel was first enacted in 1951. From initial levels of 1 cent and 2 cents per gallon, respectively, the taxes were raised gradually to 4 cents by 1959, where they remained for more than 20 years.

Proposals to increase the Federal excise tax on gasoline became common during and after the 1973/1974 Arab oil embargo and subsequent rises in crude oil prices. Coming in the aftermath of the 1973-74 oil shock, such proposals were intended largely to reduce consumption of motor fuels (by raising their prices), and thereby reduce oil imports. Perhaps best known of these proposals was Senator "Scoop" Jackson's -- to increase the tax by $1.00 per gallon. Other major proposals of the period were Senator Johnston's and Representative Anderson's 50 cents increase proposals (S. 1749 and H.R. 6071, 96th Congress). Senator Bentsen's 1975 bill (S. 973, 94th Congress) proposed a phased-in increase of up to 20 cents per gallon to be credited against income tax.

The emphasis on the revenue-raising potential of the gasoline tax began in the early 1980s as it became clear that the Federal budget was headed for large deficits over the next several years. Concern over inflation, possible impacts on low-income families, and other factors prevented many of these proposals from being adopted. In late 1982, in addition to fiscal deficits and energy security, attention began to focus on the large portion of the roads and highways in this country that had fallen into disrepair, and on the unemployment rate, which had risen steeply as a result of economic recession.

Deficit reduction also has been the key underlying objective of many of the recent proposals to hike motor fuel excise taxes. A boost in these taxes was one of the revenue-enhancing options considered seriously in negotiations over the FY1991 budget. This option received some support from those who also saw it as means of raising highway vehicle fuel efficiency (rather than by fuel economy standards). The estimated 197 million automobiles, trucks, buses and motorcycles on U.S. roads and streets in 1992 travelled an estimated 2.2 trillion miles, and used 110 billion gallons of gasoline and 21 billion gallons of diesel fuel. This use (not all of it subject to tax) yielded the Highway Trust Fund an estimated $16.5 billion in motor fuel excise tax receipts, and State and local governments $23 billion in motor fuel excise and sales taxes.

From 1983 to 1993, there have been five increases in the motor fuel excise taxes. Title I of the Surface Transportation Assistance Act of 1982 (P.L. 97-424) boosted the taxes by 5 cents per gallon (to 9 cents, effective Apr. 1, 1983). The Tax Reform Act of 1984 (P.L. 98-369) raised the diesel fuel tax another 6 cents per gallon (to 15c) in return for the repeal of a scheduled boost in truck taxes based on vehicle weights. A 0.1-cent-per-gallon tax was added by the Superfund Amendments and Reauthorization Act of 1986 (P.L. 99-499) to fund the cleaning up of leaking underground storage tanks (LUST). The final budget agreement of 1990, the Omnibus Budget and Reconciliation Act (P.L. 101-508) raised the gasoline and diesel fuel taxes by another 5 cents per gallon, earmarking 2.5 cents for deficit reduction. And the Omnibus Budget Reconciliation Act of 1993 (P.L. 103-66) raised the motor fuel excise taxes 4.3 cents per gallon, effective Oct. 1, 1993, also earmarking the increment for deficit reduction.

Effective Oct. 1, 1993 the tax rates on motor fuels for highway use will be as follows. Gasoline and special motor fuels except liquefied petroleum gas (LPG) -- e.g., benzene and naphtha -- used for highway driving: 18.4 cents per gallon (11.5 cents for the highway trust fund rate, 6.8 cents for deficit reduction, and 0.1 cents for the LUST trust fund). LPG (not subject to the LUST tax): 18.3 cents. Diesel fuel: 24.4 cents per gallon (17.5 cents for the highway trust fund, 6.8 cents for deficit reduction, and 0.1 cents for the LUST trust fund). Gasohol containing alcohol made from biomass: partially tax-exempt, the exemption amount depending upon the fraction of alcohol in the mixture. Compressed natural gas (previously untaxed): 48.54 cents per thousand cubic feet (approximately 4.3 cents per gallon).

The expiration dates of the taxes vary depending upon the component of the tax. Because the 2.5 cents deficit-reduction portion, which was to expire Oct. 1, 1995, was combined with and made permanent along with the new 4.3 cents component, 6.8 cents of the tax is permanent. The LUST tax expires Jan. 1, 1996. Thus, under the new law, the tax rates on gasoline and special fuels will be 18.4 cents from Oct. 1, 1993 through Dec. 31, 1995, and 18.3 cents thereafter. The tax on diesel will be 24.4 cents from Oct. 1, 1993 through Dec. 31, 1995, and 24.3 cents thereafter. Technically, 11.5 cents of the gasoline tax and 17.5 cents of the diesel tax expire on Oct. 1, 1999. Motor fuel taxes, however, always have had expiration dates, which always have been extended prior to the scheduled expiration.

Federal excise taxes on motor fuels for non-highway uses were raised by the 1993 Budget Reconciliation Act as follows: diesel fuel for railroads -- 2.6 cents to 6.9 cents, but then phased down to 4.3 cents; jet fuel for commercial aviation -- 0.1 cents to 4.4 cents effective Oct. 1, 1995; fuels for noncommercial aviation -- 17.6 cents to 21.9 cents; and fuels used in commercial vessels on inland waterways -- 17.1 cents to 21.4 cents. (These taxes are not covered in this issue brief.)

In addition to the Federal Government, all States impose excise taxes on both gasoline and diesel fuel. (Like the Federal taxes, most State taxes are flat rates per gallon; some States impose advalorem taxes -- a percentage of dollar sales; a few do both.) Several States and a number of local governments impose sales or other taxes in addition to excise taxes. As of May 1993, State excise taxes on gasoline and/or diesel fuel ranged from 7.5 cents to 28 cents per gallon. One-fifth of the States exempt gasohol from at least part of the regular gasoline tax. The average U.S. retail price (including taxes) of gasoline in June 1993 was $1.194 per gallon; the corresponding price for diesel fuel probably was a few cents lower.

Taxes on motor fuels in the United States are lower than in all Western European countries. The International Energy Agency (IEA) estimates that the combination all U.S. Federal and State taxes (including general sales taxes) on unleaded regular gasoline averaged 40.1 cents per gallon in the fourth quarter of 1992, or 34.6% of the average price. Taxes on gasoline in Western European countries (including value added taxes, customs duties, and retail excise taxes) averaged $3.65 per gallon in the same period, 70% of the average price of gasoline, based upon IEA data.

ECONOMIC ISSUES

This section surveys the major economic and fiscal consequences that probably would result from boosts in the Federal excise taxes on both gasoline and diesel fuel (whether as stand-alone increases or as part of a broader measure). Quantitative estimates mainly are made with respect to increases of 4.3 cents, 10 cents, 25 cents, and 50 cents per gallon. Most of the discussion assumes that the revenues from increases would be used to reduce the Federal budget deficit.

MARKET RESPONSE

Higher gasoline taxes would be viewed by the taxed entities -- refiners, terminal operators, and importers -- as an increase in the cost of doing business. Initially, they would tend to raise the price of fuel to include the full amount of a tax boost, but buyers would purchase somewhat less motor fuel at the higher price. As a result, marketers and, therefore, refiners probably would have to settle for a smaller price rise than the amount of the tax boost. Part of the increase in the tax thereby would fall on the seller of the fuels, whose net revenues per gallon (the net price they received after paying the tax) would be less than before the tax increase. Thus, refiners and motor fuel marketers and, probably, the oil industry in general would receive less revenue than they otherwise would. Retail buyers would absorb that part of the tax boost represented by the increase in price.

Price elasticity is a measure of the responsiveness of quantities supplied or demanded (by sellers and buyers, respectively) to changes in price. Thus, it can be said that the more elastic is the supply of gasoline compared with the elasticity of the demand for gasoline, the larger will be the ultimate rise in the selling price as a result of a tax boost and the greater the "incidence" of the tax increase on buyers. The respective elasticities will each be larger in the long run (when there is sufficient time to fully change behavior and/or equipment, or to re-allocate factors of production) than in the short run (when only minor adjustments can be made).

The large number of estimates of demand price elasticity of gasoline, based upon empirical studies, average about -0.25 for the short run and -0.8 for the long run. (A demand price elasticity of -0.25 means that the quantity purchased will decrease 2.5% for every 10% increase in price.) Basic economic theory and the results of empirical research suggest that the supply price elasticity of motor fuel is much greater than the demand price elasticity. Therefore, refiners and marketers probably would be able to pass on most of an excise tax boost to buyers. It is assumed in this Brief that the supply price elasticity is three times (in absolute terms) the demand price elasticity.

MOTOR FUEL PRICES

Increases in motor fuel excise taxes eventually would result in rises in the retail prices of motor fuels, but probably by less than the amounts of tax increase. Applying the demand and supply price elasticities assumed above, it follows that roughly three-fourths of a motor fuel tax hike ultimately would be reflected in an increase in price. Thus, boosts of 10 cents and 25-cent could be expected to lead to price rises of 7.5 cents and 18.75 cents per gallon of gasoline on average. These would represent increases of 6.4% and 16.0%, respectively, from the April 1993 average price of gasoline ($1.175). A tax boost of 4.3 cents per gallon could be expected to lead to a price rise of about 3.2 cents per gallon, or about 2.7%.

PETROLEUM CONSUMPTION AND IMPORTS

Using the assumed demand and supply price elasticities, the April 1993 gasoline price, and a 25 cents increase in the Federal excise taxes, motor fuel use would be 4.0% (-0.25 x 0.16) below its level in the absence of a tax boost in the short run (about a year), and 12.8% (-0.8 x 0.16) below what it would be in the long run. Using DRI's projected 1993 level of taxable motor fuel use of 8.52 million barrels per day (bbls/day) for gasoline and diesel fuel combined as a base, the consumption drop would be about 340,000 bbls/day in the short run and 1,090,000 bbls/day in the long run. A tax increase of 4.3 cents would lead to about one-fifth of the above numerical results.

As the marginal source of petroleum in the United States, imports would bear nearly all, if not all, of the consumption effects. Imported crude oil generally is more costly than domestic oil to U.S. refiners, who would tend to cut their purchases of the former rather than the latter when demand for refined products falls. (Well under 5% of U.S. gasoline and diesel fuel use is supplied by imports of those products.) With net imports of crude oil (including oil for the Strategic Petroleum Reserve) and refined products projected by DRI/McGraw-Hill (DRI) to average 7.16 million bbls/day in 1993, the effect on imports of a 4.3-cent tax boost would be exceedingly small in the short run and small in the long run.

IMPACT ON THE OIL INDUSTRY

Higher motor fuel taxes tend to adversely affect the oil industry, mainly refiners and gasoline marketers. As discussed above under "Market Response," an increase in motor fuel taxes reduces gasoline use and diminishes the price per gallon actually received by refiners and marketers. Assuming as before that roughly three-fourths of the increase would be passed through to end users, and the quantities demanded would decrease, a 25-cent tax boost would reduce annual final sales by the industry by an estimated $21 billion in the long run (using DRI-projected 1993 volume and price levels). This would be an 18% reduction in industry retail sales of highway motor fuels. Some of the reduction effectively would be borne by foreign suppliers of petroleum.

As the impact on demand for motor fuel would suggest, domestic refinery capacity utilization could be noticeably reduced, probably leading to the closing of some refineries and motor fuel retail outlets. To the extent that sellers of motor fuels would absorb an increase in the excise taxes (thereby receiving less per gallon excluding taxes), and to the extent that such absorption was passed back to crude oil wellhead prices, domestic oil producers also would be harmed. Profits of the industry as a whole would be reduced, at least in the short run. These impacts on the oil industry would be mitigated to the extent that the tax boosts are passed on to users to a greater extent than assumed above, and that buyers maintain their previous volume of purchases. But the extent of such forward shifting probably would be limited in the foreseeable future by a reasonably ample supply of gasoline and of refinery capacity in the world market.

MACROECONOMIC RAMIFICATIONS

An increase in the motor fuel excise taxes for the purpose of reducing the Federal budget deficit would (1) reduce households' disposable income and, therefore, reduce consumer spending, and (2) increase businesses' costs per unit of output (assuming business users are not able to pass on all of the tax increase to their customers) thereby reducing profits (ultimately). Investment would be reduced (at least in the short run) to the extent that energy and capital are complements in production, since business use of motor fuels would decrease as a result of higher prices. The decreases in demand for goods and services would have a contractive effect on economic activity, and real Gross Domestic Product (GDP) would grow less rapidly.

In addition, higher fuel prices would tend to boost the general price level. The higher costs of doing business would be passed through as higher prices for goods and services, and also result in boosts in wages and salaries tied to changes in the Consumer Price Index (CPI), which would add to the costs of businesses as well. In general, rigidities in the economy would prevent a corresponding drop in the prices of other goods and services, leading to additional contractive effects. An increase in the general price level could be prevented or eased by slowing the growth in the supply of money, but this could worsen the contractive effects. In the short run, the increase in fuel prices would result in a one-time increase in the price level and the rate of inflation. A 10% rise in the prices of motor fuels by itself would raise the CPI by about 0.3%, since those fuels account for about 3% of total expenditures covered by the Index.

The magnitude of these effects depends largely on the size of the tax increase: the larger the increase, the greater the contractive effect. Based on the revenue estimates presented later, a tax increase of 25 cents per gallon would translate, in the short run, into an annual $31-billion gross transfer of resources from consumers and business to the Federal Government. That amount would represent about 0.5% of GDP and 0.7% of disposable personal income at projected 1993 levels. It should be noted that motor fuel taxes would tend to have smaller macroeconomic effects than taxes applied primarily to primary or intermediate inputs, to the extent that motor fuels are purchased for "final" consumption (rather than as primary or intermediate inputs).

The contractive effects of motor fuel excise tax boosts enacted to reduce the Federal budget deficit could be mitigated at least partially by (1) any lowering of interest rates, which could result from smaller Federal budget deficits, (2) the extent to which consumers pay the additional taxes by reducing their saving rate, (3) decreases in income transfers to foreign countries resulting from a decrease in oil imports, and (4) an improved trade balance resulting from the fall in the value of the dollar relative to other currencies, due to lower interest rates reducing net capital flows into the United States. However, a drop in consumer savings rates would tend to raise interest rates, offsetting some of the trade and budgetary impacts of higher motor fuel taxes.

Among other international ramifications, lower U.S. interest rates could tend to reduce the interest rates paid by debtor nations such as Mexico, Nigeria, and Venezuela that are suppliers of imported oil. But a decrease in U.S. oil imports would decrease those suppliers' oil revenues, and worsen any financial problems in those countries.

In the long run, other things being equal, the RATE of price inflation should return to that existing prior to the tax increase, but with the general price LEVEL higher than it would be in the absence of a tax boost. Money supply accommodation of a tax increase, however, could lead to a change in inflationary expectations (and a price spiral); and monetary accommodation to such a situation could lead to a long-lasting increase in the rate of inflation.

Using the DRI macroeconomic model of the U.S. economy, CRS simulations of a phased-in boost in the motor fuels taxes of 30 cents per gallon (in annual increments of 10 cents) show the following effects relative to a base case in the third year: a decrease in the growth rate of GDP from 2.6% to 2.5%; an acceleration in inflation (measured by the implicit price deflator) from 2.6% to 2.7% per year; a rise in the unemployment rate from 6.1% to 6.3%; and a reduction in the merchandise trade deficit from $111 to $101 billion. Long term interest rates (on 10-year Federal Government bonds) decline, not insignificantly, from 7.1% to 6.9%, while short term rates (on T- bills) are unchanged.

ECONOMIC EFFICIENCY

While excise taxes, in general, tend to distort the allocation of resources more than other kinds of taxes yielding equal revenue, the motor fuel excise taxes actually may improve allocation, and thus the efficiency of the economy. By raising the cost of motor fuel and reducing driving, the taxes may correct for the extent to which prices of motor fuels fail to fully reflect the costs to society associated with vehicle use -- such as the economic losses and medical costs associated with highway accidents and illnesses from emission-caused air pollution, the unpleasantness of urban congestion, and the risk of climate change. In addition, if there are social costs of the importation of oil not reflected in imported oil price, motor fuel taxes may improve efficiency by reducing motor fuel use, and, therefore, oil imports. In economic terms, the taxes compel drivers to internalize at least some of the external costs of driving. Motor fuel taxes also may serve an allocative function to the extent they are user's fees for the privilege of using roads and bridges. They promote efficiency by serving as a price for benefits received.

An increase in the taxes could further improve economic efficiency in each of these respects if the taxes presently are too low. Current gasoline and diesel fuel tax rates do not generate enough revenue to cover highway construction and repair costs, even if the revenues from the deficit reduction rate of 2.5 cents per gallon were designated for the Highway Trust Fund. This suggests that the "user fee" component is less than it should be, and that current tax rates do not fully address the external costs. The "correct" tax rate for each of these external costs would have to be determined, however.

DISTRIBUTIONAL EFFECTS

The Federal gasoline excise tax is widely believed to be regressive -- its burden falling more heavily on lower income than on higher income households. This belief is based largely on cross- section single-year data from surveys of household spending and income, which show that motor fuel expenditures as a proportion of income decline as income rises. For example, the Bureau of Labor Statistics' survey of 1989 consumer expenditures shows that households in the lowest quintile (lowest 20% of the income distribution) spent 7.9% of their before-tax income on gasoline, versus 1.9% for those in the highest quintile. Households in the 2d, 3rd, and 4th quintiles spent 4.9%, 3.9%, and 3.1% of their pre-tax incomes, respectively. This suggests that the tax component of those expenditures declines in a similar pattern, i.e., the gasoline tax is regressive.

For several reasons, however, the regressivity may be less than commonly believed. Perhaps most significant, when total EXPENDITURES are used as the measure of well-being to which spending for motor fuel is related, the relative burden of the taxes declines less rapidly than when income is used to measure well-being. One aspect is that many lower-income households are young and will experience rising incomes over their life cycles; their spending for motor fuel (including taxes) will fall relative to income. Also, young households tend to borrow against future income to finance current spending. In addition, some lower-income households have income that is not measured by the surveys, such as income in kind. However, focusing only upon spending ignores saving by middle and upper income groups, which represents part of their living standard.

Second, low-income households that use public transportation, buying no motor fuel directly, are not affected by or may benefit from increases in motor fuel taxes. Some of these households and others receive government transfer payments that are indexed to the general price level. A hike in the taxes would raise inflation and result in higher transfer payments. However, increases in transfer payments lag price rises, and such households would experience purchasing power losses in the interim. Third, contrary to the assumption of most empirical studies of motor fuel tax regressivity, the taxes may not fall totally on consumers. Data and estimation difficulties cause most such studies to assume that the taxes businesses pay on motor fuels are passed forward completely in the form of higher prices; the studies "distribute" the burden among consumers on the basis of income. But, given the estimates of demand and supply price elasticities, the taxes may be borne at least partially by petroleum suppliers.

Another consideration is that revenues from the motor fuel taxes are almost entirely earmarked for the Highway Trust Fund, and are allocated back to the States to pay for highways, bridges, and other infrastructure. All drivers, regardless of income, benefit from these expenditures, more or less in proportion to how much highway driving they do. To the extent this makes motor fuel taxes "user fees" or benefit taxes (prices for the benefits received from the provision of a public good), the distributional effects of the highway spending would be as relevant as those of the taxes.

To the extent that regressivity is a concern, it could be offset in one of several ways. According to a Congressional Budget Office report, the regressivity of a rise in the taxes may be offset by an increase in the earned income tax credit or an increase in food stamp benefits. The entire additional or total motor fuel tax liability could be rebated through a credit against income tax payable. Congress could achieve virtually any distributional pattern to the motor fuel tax burden that it chooses. (For a more detailed discussion of the regressivity issue, see CRS Report 91-816 E.)

REGIONAL EFFECTS

Another issue of major concern to the Congress is the pattern of regional tax burdens. It has been found that taxes on energy use such as motor fuels do not fall evenly across regions of the United States. Per-capita gasoline purchases varies widely by State, ranging from 610 gallons per year by Wyoming residents to 277 gallons by residents of the District of Columbia (in 1991). More than half of U.S. petroleum refining capacity is concentrated in Texas, Louisiana, and California. A 1986 CRS study found that a gasoline tax increase would impose a greater burden on oil producing and refining States, along with large rural western States, than on small more urbanized northeastern States. Depending upon how much of a tax increase is absorbed by producers or refiners, the burden on the first two groups of States could be several times that on the third group. (For a detailed analysis and State by State estimates of the regional effects of a gasoline tax increase, see CRS Report 86-637 E.)

Another regional, or local, effect of an increase in Federal motor fuel taxes concerns State and local government finances. Because higher Federal taxes reduce use of motor fuels, all States would see a decline in their excise tax revenues (since all States tax motor fuels). Those States that impose ad-valorem excise taxes (percent of price) would see a larger revenue decline because of price as well as quantity effects. Further, States might be partly or unevenly precluded from increasing their own motor fuel excise taxes. States that may wish to raise their taxes in the future may face increased resistance from citizens who had been hit recently with a Federal tax hike. In any one year, many State legislatures at least consider hiking motor fuel taxes.

OTHER MARKETS AND INDUSTRIES

An increase in the motor fuel excise taxes (only) affects non- energy markets and industries. Any resulting increase in the prices of gasoline and other motor fuels, other things being equal, would mean the cost of vehicular transportation and related travel had risen relative to the cost of other goods and services. Motor fuel users would tend to substitute other goods and services for vehicular travel.

Most directly, many people would drive less. Inasmuch as the average passenger car uses about 500 gallons of gasoline a year, a tax increase of 25 cents per gallon (resulting in a 18.75 cents price increase) would add about $95 to the annual costs of operating an automobile, before taking into account any adjustment in miles driven. A tax increase of 4.3 cents per gallon would add about $15 to unadjusted annual operating costs. Trucks use about 1,400 gallons of motor fuel per year on average, but the effect of a price increase on business is reduced by the deductibility of ordinary business expenses for income tax purposes. In addition, over time, many consumers would tend to substitute more fuel-efficient autos or trucks for their present vehicles, other things being equal.

If the tax boosts and consequent price rises are big enough, purchases of autos and trucks would be less than otherwise. The shift to more fuel efficient cars in response to the higher tax rate might benefit the domestic auto industry due to the fuel economy standards, which mandate that manufacturers build fuel efficient cars, and the stiff gas-guzzler taxes on larger cars. Indirectly, less intensive use of cars probably would decrease demand for auto care services, and for goods and services related to travel and tourism. Substitute or near-substitute recreational goods and services may benefit.

In the case of a general transportation fuels tax, however, the relative cost of all transportation services would rise, reducing any tendency to shift from highway to other forms of transportation.

REVENUE ESTIMATES

Most motor fuel tax hike proposals concern only gasoline and diesel fuel, because they generate the most revenue. However, such proposals inevitably raise questions about exemptions for gasohol and other fuel types, which total hundreds of millions of dollars in foregone revenues. Federal excise taxes on noncommercial aviation fuels, inland waterway vessel fuels, and fuels derived from natural gas together yielded about $1 billion in FY1990.

GROSS INCREASE IN REVENUES

According to CRS estimates, a 4.3 cents-per-gallon boost in the Federal gasoline AND diesel fuel excise taxes will yield $5.45 billion in GROSS additional receipts the first full year the increase would be in effect, and $5.09 billion in the tenth year, other things equal. Thus, the gross yield on this size of tax hike in the first year would be $1.27 billion per penny (per gallon) of tax increase, and $1.18 billion in the tenth year. Larger tax boosts would yield lower revenues per penny of increase; a 25-cent increase, for example, would yield $30.6 billion and $26.2 billion, respectively. As discussed below under "Deficit Reduction," the estimates reflect only the direct effects of a tax hike.

The estimates shown in the table are estimates of additional receipts, taking into account likely adjustments by buyers and sellers to the higher prices that probably would result from a rise in the taxes. As suggested above, any increase in the motor fuel taxes would boost receipts from those taxes by somewhat less than the ratio of the higher tax rate to the present rate. Because markets are reasonably competitive, buyers and sellers could and would change the amounts they buy and sell so as to minimize the effects of the tax increase. These changes would tend to be larger with the passage of time, as economic units have more time and economic latitude to change their behavior. For the sake of isolating the effects of a tax increase, it is assumed here that there are no other changes in the volume of fuel used or in the prices of fuel.

   TABLE 1. ESTIMATED ADDITIONAL GROSS REVENUE YIELD OF HYPOTHETICAL

Note: Estimates use projected 1993 fuel use and prices (without a tax increase) as base case. Assumed price elasticities are -0.25 for demand and +0.75 for supply in the first year, and -0.8 and +2.4 for demand and supply, respectively, for the tenth year.

a: Revenue yield is designated "gross" because probable direct and indirect effects of increases in fuel prices on other Federal revenue sources have not been considered in the estimation process. See text for further discussion.

DEFICIT REDUCTION

The revenue estimating procedure described above includes only the direct impacts of the hypothetical motor fuel excise tax increases on motor fuel tax revenues. The procedure does not consider the dynamic effects of the tax increases on economic activity, or the effects on Federal Government expenditures. The "fiscal drag" presumably resulting from a tax measure to reduce the Federal budget deficit is likely to decrease consumer and business purchasing power, reduce economic activity, and thereby decrease Federal revenues from income and other taxes. Second, because a higher general price level would tend to depress economic activity, if not countered by easier monetary policy, personal and business incomes would be lower than otherwise, and individual and corporate income tax revenues also would be lower than otherwise. Third, Federal spending for welfare, unemployment benefits, and motor fuels also would rise. Thus, these offsetting tendencies imply a smaller net deficit reduction than the increase in revenues.

Some analyses suggest that these countervailing effects can be significant. The results of the DRI model simulation described earlier show that net deficit reduction is about two-thirds of the increase in revenues -- the remaining one-third comprises increases in Federal expenditures and decreases in income, sales, and payroll taxes. This effect is consistent with other studies. A 1988 Federal Reserve study found that a 15-cent tax increase would generate $15 billion in revenue the first year, but increase Federal Government spending and decrease other revenues by a total of $6 billion, for a net cut in the deficit of $9 billion.

REVENUE COLLECTION AND DISPOSITION ISSUES

Focus on motor fuel taxes stems from concern by some that the system for collecting those taxes leads to compliance problems and tax evasion (which reduce revenues and increase deficits) as well as from the desire by some to increase those taxes. Moreover, the system for disposing of the revenues also raises questions, although it has been less a concern to policymakers than the collection system.

COLLECTION

The Federal excise tax on DOMESTICALLY PRODUCED gasoline is imposed on either the refiner or the terminal operator. The taxable event is either the removal of the gasoline or the sale to any person who is not registered with the IRS as a refiner or terminal operator. The tax is not imposed on bulk transfers of gasoline, by pipeline or vessel, from refiners to terminals provided that the transferor and terminal operator are registered with the IRS. The effect of these rules is to impose the tax on the removal of the gasoline from a terminal at the rack (as it "breaks bulk") and to make the terminal operator, typically the owner of the fuel at the time of removal, generally responsible for collecting and remitting the tax monies. The tax on IMPORTED gasoline is imposed on the importer when the fuel is removed from customs custody, again excepting bulk transfers to terminals. The collection point of the tax on DOMESTIC diesel is further downstream, when taxable fuel is sold by a producer or importer. A producer is defined to include a refiner, compounder, blender, or wholesaler. Since the taxable event is the sale of the diesel, the tax also can be collected at the retail stage.

Some motor fuel uses (such as farming, other off-highway uses) and some types of purchasers (educational institutions, State and local governments) are tax-exempt. All gasoline sales to final users include the tax; the tax exemption is realized through a refund or a credit against income taxes where applicable. Gasohol blenders may buy gasoline tax-free. For diesel fuel, tax exempt purchases are permitted for quantities to be used as heating oil, and for other off-highway exempt uses. All diesel producers and tax-exempt purchasers must register with the IRS, which may require bonds and liens.

THE EVASION PROBLEM

The current motor fuel tax collection systems are relatively new, the result of changes enacted over the last 7 years. Prior to 1987, the gasoline tax was imposed on producers and importers, defined essentially the same as under the current diesel collection system. Producers initially were defined to be refiners, terminal operators, wholesalers, and later, retailers with 10 or more stations. The taxable event was the first sale of the gasoline; producers could make tax-free sale of gasoline to tax-exempt users. The tax on diesel and special motor fuels was collected at the retail level.

These collection systems, with different possible collection points and the ability to make tax-exempt sales, became a serious concern to Congress and to some petroleum marketers. Evidence showed extensive tax evasion, leading to hundreds of millions of dollars (billions, according to some) in revenue losses. Part of the concern is that honest sellers are disadvantaged competing with tax-evaders, whose lower costs (due to evasion) permit lower prices. Evasion of the diesel tax was estimated to be two to three times that of the gasoline tax, resulting in relatively larger revenue losses. Four factors were important: (1) the diesel tax was collected downstream from any one of several types of entities, and thus had different possible collection points and many remitters; (2) the tax rate is higher than that on gasoline; (3) the fuel can be sold tax-free; and (4) the fuel is almost identical with home heating oil, which is not subject to the tax.

The Tax Reform Act of 1986 (P.L. 99-514) repealed all tax-free sales and moved the collection points upstream, cutting the number of collectors and remitters from about 8,000 to about 500 according to Treasury Department estimates. The Technical and Miscellaneous Revenue Act of 1988 (P.L. 100-647) reversed some of the 1986 Act changes, permitting tax-free diesel fuel sales, provided that buyers meet registration, bonding, and reporting requirements.

The changes in the point of collection raised concern among certain petroleum marketers and tax-exempt buyers. Wholesalers, required to pay the tax in the form of a higher price, objected to moving the point of tax collection upstream to terminal operators or refiners. They wanted to continue to collect the tax and remit it to the Treasury, and to use the lag between collection and remittance to improve their cash flow and interest income earned on collected but unremitted taxes; and they argued that new requirement gives some terminal operators, who may be competitors as well as suppliers, a competitive advantage. Terminal operators objected to the new bonding and registration requirements, arguing that it was too expensive to post a bond, and that companies with a good track record in paying taxes should not have to post a bond. Tax-exempt buyers, primarily farmers and State and local governments, objected to purchasing gasoline on a tax-paid basis and filing for a tax credit or refund.

Congressional proposals in recent years to move the point of collection of the diesel tax further upstream, similar to gas tax collection, bore fruit in 1993. The Budget Act provides that the tax on diesel fuel will be collected on removal from the terminal. To facilitate tax-free sales to qualified buyers (most notably, farmers), fuel destined for tax-exempt uses may be marked (dyed, for example). The change in diesel tax collection applies to fuel removed from terminals after Dec. 31, 1993.

DISPOSITION

Before 1956, revenues from the Federal motor fuel excise taxes went into the general fund of the Treasury. When the gasoline tax was first imposed in 1932, it was intended as an emergency revenue- raising measure with some luxury-tax overtones at a time when the Depression and rapid growth of Federal Government outlays for relief and public works programs were creating relatively large Federal budget deficits. The Highway Act of 1956 (P.L. 84-627) established the Highway Trust Fund and required nearly all revenues from the motor fuel excise taxes to be deposited in the Trust Fund, which was to be used only for highway purposes. This sole dedication of revenues, which held until 1983, was the original basis for calling the motor fuel excise taxes "user fees." The 1982 Surface Transportation Act provided that the revenues derived from 1 cent of the 5-cent increase in the motor fuel taxes would be allocated to certain mass transit purposes. The boat fuel taxes go to a land and water conservation fund.

The 1990 legislation that boosted the gasoline and diesel taxes by 5 cents also specified that revenues from 2.5 cents of the increase be placed into the general fund, for deficit reduction. The 1990 tax boost thus departed from the practice of earmarking receipts from those taxes for transportation purposes. Many opponents of a Federal motor fuel tax rise for deficit reduction claim that such an action would threaten the sources of funding for transportation infrastructure at the national and State levels.

The Budget Reconciliation Act of 1993 increases the amount of highway fuel taxes earmarked for deficit reduction from 2.5 cents to 6.8 cents per gallon effective Oct. 1, 1993. Effective Oct. 1, 1995, however, 2.5 cents per gallon is shifted to the Highway Trust Fund; this leaves 4.3 cents per gallon earmarked for deficit reduction, and increases to 14.0 cents per gallon the amount earmarked for the Highway Fund.

LEGISLATION

P.L. 103-66, H.R. 2264

Omnibus Budget Reconciliation Act of 1993. Provides for reconciliation pursuant to Section 7 of the concurrent resolution on the budget for FY1994. Introduced May 25, 1993. Passed House May 27. Passed Senate in lieu of S. 1134, amended, June 25. Conference Report (H.Rept. 103-213) filed June 14. Passed the House August 5 and the Senate August 6. Signed into law Aug. 10, 1993.

H.R.242 (Lipinski)

Provides financial assistance for the repair, reconstruction, and rehabilitation of highways, bridges, transit facilities, airports, and wastewater treatment works, partly through a dedicated 7.5 cent-increase in the per-gallon taxes on gasoline, diesel, and some other fuels effective Jan. 1, 1994; also increases by 3 cents per gallon the deficit-reduction portion of the taxes. Introduced Jan. 5, 1993; referred to more than one committee.

H.R.2406 (Istook)

Provides Internal Revenue Service with increased authority and resources to be used in reducing evasion of the diesel fuel tax and of other taxes. Introduced June 14, 1993; referred to Committee on Ways and Means.

H.Res. 37 (Upton)

Expresses the sense of the House of Representatives that the Federal excise taxes on gasoline and diesel fuel shall be used exclusively to meet the Nation's transportation needs. Introduced Jan. 21, 1993; referred to more than one committee.

H.Res. 50 (Solomon)

Expresses the sense of the House of Representatives that in light of current economic conditions the Federal excise taxes on gasoline and diesel fuel shall not be increased. Introduced Jan. 26, 1993; referred to Committee on Ways and Means.

S.1068 (Robb)

Reduces the Federal budget deficit and encourages energy conservation through an increase in the motor fuels excise tax, by 50 cents per gallon over 5 years, and for other purposes. Introduced May 28, 1993; referred to Committee on Finance.

S.Amdt. 697, to H.R. 2519 (Kerrey)

Expresses the sense of the Senate that disaster relief payments during 1993 be funded by a temporary gasoline tax. Introduced July 27, 1993.