Tax evasion has always been the back-alley partner of taxation. Countless news stories of fraud and tax evasion litter the news once tax season is upon us. But one of the costliest evasion “industries” is rarely seen, and little understood.
Federal Income taxes disappear into the general fund abyss. State sales taxes can fund anything from a salary to the cost of lawncare at the state capital. But one of the few taxes Americans pay which has a direct cost-benefit connection are Fuel Taxes which drive the Highway Trust Fund (HTF). This fund’s revenues come mostly from gasoline and diesel taxes though taxes on trucks and trailers, tire taxes on trucks, and “use tax” on certain vehicles make up 13.5% of HTF revenue. In turn, these funds are used almost exclusively for the improvement of America’s roads, bridges, and mass transit infrastructure. Fuel Tax Evasion (FTE) thus directly impacts the health of America’s highways, roads, and bridges. The problem is that FTE is one of the hardest types of tax evasion to catch and thus, to quantify. Federal and State Governments know it is happening, but are unsure as to how much is actually being lost to it.
The Highway Trust Fund
To understand the impact of FTE, an understanding of the HTF and its in-born problems need to be discussed. The fund is separated into two categories: the Highway Fund and the Mass Transit Fund. The Highway Fund receives the lion’s share of tax revenues and is used for highway, road, and bridge infrastructure capital outlays, maintenance, and repairs, mostly in direct payments to states. The Mass Transit Fund pays for rail, buses and streetcars.
Roughly 70% of all spending on roadway infrastructure comes from state and local government with the feds picking up the remainder through the Highway Trust Fund. Each state has its own version of the HTF in levying its own fuel taxes per gallon. Some counties and even cities add a separate fuel tax on top of state tax rates for roadway improvements.
Despite the fact that other federal spending habits are clearly bloated and rife with irresponsible practices, the Highway Trust Fund does largely go toward direct payments for road maintenance and construction outlays, with one recent exception. The Transportation Alternatives Program, a subset of spending in the HTF spent $820 million in 2014 on “sidewalks, bike paths, scenic overlooks, vegetation management, and recreational trails” according to a Heritage Foundation study. Regardless of such diversions, the Trust Fund’s problem is not how money is spent: its problems instead stem from three separate yet interconnected issues: underfunding; increased need; and fuel tax evasion.
Taxable fuels (gasoline, diesel, kerosene etc...) account for over 85% of the Highway Trust Fund’s receipts. The current federal tax on a gallon of gasoline is 18.4¢ while diesel is 24.4¢. This rate has gone unchanged since 1993. Twenty-four years without any increase by the Feds coupled with dropping fuel consumption has led to a stagnant revenue stream for the fund. When looking at the fund’s annual revenues from 1956 (when the fund was created) to 2014 compared against inflation adjusted dollars, revenue has been on a steady decline since 2010, and on an average decline since 2003.
According to the National Conference of State Legislatures, “Transportation funding has been in a near constant state of crisis for about a decade.” The problem is that Americans are consuming less gasoline and thus paying less fuel taxes. Increased vehicle fuel efficiency and low fuel prices in recent years have combined to dull fuel tax revenues. Annual consumption in 2009 fell to its lowest levels since 1984. After continued declines to 2014, 2016 saw the largest surge in consumption in over four decades. Regardless, total consumption is down nearly 40% from its high in 2003.
The Highway Trust Fund tends to overspend as well. In 2015, the HTF spent $44 billion on transportation infrastructure work while only taking in $34 billion in tax revenues according to the Congressional Budget Office (CBO). Since the Fund is legally not allowed to run a deficit, it has consistently come close to insolvency, requiring bailout dollars to be transferred from the Congressional General Fund. In January 2016, $51.9 billion was transferred from the General Fund for this purpose. In October 2013 the fund received $10.4 billion from the General Fund. Of the last six fiscal years, deficit spending by the fund’s highway account totaled $24.5 billion dollars. (These numbers do not include deficits or receipts in the Mass Transit account).
In an attempt to make a dent in the tremendous shortfalls in the Highway Trust Fund, in December of 2015, President Obama signed into law the FAST Act (Fixing America’s Surface Transportation Act) which is a five year authorization of $305 billion for federal surface transportation programs. However, states seem to be contending with uneven allocation of FAST funds.
In looking at the sheer mileage of roadway per state, the top ten states with the most lane miles are not necessarily the top ten recipients of FAST dollars. The top ten recipient states accounted for 66.5% of the 11 billion dollars directly allocated to states in 2016 yet these same states hold just 29.5% of all road miles in the United States (urban and rural included). The clearest disparity is in Michigan where the state holds fully 3% of the country’s 8.69 million miles of roads yet only received 1.17% of FAST funding. Additionally, their roads are rated as being among the top 3 states with the most roadway miles in poor condition. In contrast, California received 19.1% of these funds yet holds 4.6% of the country’s total road miles in its borders (Texas has the most road miles in the country with 7.9%). Of course, a large portion of FAST Act Funds are earmarked for mass transit projects which by default go to states with larger urban populations which may, in part, explain the disparity beyond political favoritism.
Despite one-time fixes like the FAST Act, annual deficits of the Highway Trust Fund are expected to continue, and grow. According to the Congressional Budget Office (CBO), by 2025 the HTF will be running an annual deficit of $22 billion dollars with a cumulative deficit of $168 billion. These numbers do not reflect state shortfalls in highway spending as they are responsible for 70% of the total expenditures on roadway construction, maintenance and repairs.
Worse, these shortfalls aren’t even keeping up with the actual needed spending to improve the country’s roadway infrastructure. In their 2017 “Infrastructure Report Card”, the American Society of Civil Engineers (ASCE) estimated there is currently “a $836 billion backlog of highway and bridge capital needs” in giving the country’s roads infrastructure a grade of “D”.
Since the feds have not increased fuel tax rates in twenty-four years, many states have felt forced to do so as they shoulder much more of the burden. Though seventeen states have not raised their state fuel tax rates in the last ten years, and three actually lowered their rates, the remaining thirty have raised their fuel tax by an average of 7.3¢ with Pennsylvania leading the pack with total ten year long increases of 27¢. All but four states charge rates equal to or higher than the 18.4¢ Federal rate. Eight states charge twice the rate with Pennsylvania charging over 3 times the rate at 58.2¢ a gallon. Their total per gallon rate is thus the highest in the nation at 76.9¢ per gallon of regular gasoline while diesel is assessed a 99.1¢ per gallon tax.
Of those behind on inflation rate increases, New Mexico and Illinois for example, brought in 25% less revenue in 2014 than they did in 1994 according to Governing.com. In thirty-seven states, inflation-adjusted revenues from fuel taxes have dropped since 2000.
The condition of America’s highways, roads, and bridges is dire in many respects. According to Federal Highway data, roads rated as being in “poor condition” average 25% across the nation with California and Michigan leading the pack of large states with 51% and 40% respectively. Detroit’s roadways are in shambles.
The ASCE indicates that “One out of every five miles of highway pavement is in poor condition.” The need is estimated to be costing America’s overall economy tens of billions of dollars in wasted expense. A report by the Heritage Foundation estimates that poor road conditions cost the average driver an extra $450 a year. The Federal Highway Administration estimates that “each dollar spent on road, highway, and bridge improvements returns $5.20 in the form of lower vehicle maintenance costs, decreased delays, reduced fuel consumption, improved safety, lower road and bridge maintenance costs, and reduced emissions as a result of improved traffic flow.”
The Elephant in the Room: Fuel Tax Evasion (FTE)
Fuel Tax Evasion is arguably the single most damaging element facing America’s vital highway infrastructure when considering its impact to the HTF. The vast landscape of the types of FTE which are taking place requires a separate article just explain them, let alone to understand their impact (see article page 12, “The Vast Landscape of FTE”). From importing cheaper fuel from states with lower tax rates (known as “bootlegging”) and simple under-reporting of total fuel receipts to more complex schemes such as cocktailing and Daisy-Chains, the billion dollar plus losses in fuel tax revenues along the supply chain are devastating the country’s roadway infrastructure. The multitude of evasion schemes are enabled by problematic and costly enforcement, the relative ease by which some methods can be perpetrated, and the often complex and varying methods of tax collection, all driven by the vast profit which can be made from it.
Collecting the Tax
At the Federal level, taxes are paid in every state “at the rack” (terminal). This was not always the case. But since the Federal government moved its point of taxation in all states in 1986 to the terminal level, revenues have increased for the feds. This change reduced the number of federal fuel taxpayers from 8,000 to 1,000 and simplified tracking. But clearly this move did not stop all forms of fraud. Additionally, taxing diesel fuel at the rack, while still selling tax-exempt diesel at those same terminals, leads to other types of evasion in the form of refund and tax credit fraud. And though several states have gone to the rack for taxing, many states have faced industry opposition to moving taxation out of the hands of distributors.
At the state level, collection varies widely and can take place at various points along the distribution chain. This also leads to gaps in tax collection. Twenty-four states apply taxation at the distributor level, meaning, when distributors (wholesalers) sell their product to end users, they are responsible for paying the tax rate assessed by the state. Nineteen states require taxes to be paid upon removal from the terminal. Seven states indicate taxes should be collected by the “first receiver” below the rack. Some states even split their taxation points between gasoline and diesel. In Oregon, gasoline taxes are collected at the distributor level while diesel taxes are collected at the retail level. California assesses diesel taxation at the refinery if the load is to be taken to a bulk plant.
The price per gallon paid at the rack can change daily in some cases which leads to wholesalers, who have several options for purchasing from different terminals or bulk plants, loading from different locations from day to day. This further leads to potential tax evasion as distributors are not bound to any one terminal.
Recent reports on estimated levels of fuel fraud are few with the independent research group Battelle performing the most recent comprehensive study in 2008. This report did not draw conclusions as to potential amounts lost in revenue but provides 192 pages of information pointing to the likelihood that FTE is virtually out of control.
Conclusions can also be drawn from past studies, and those conclusions are astonishing. Though it was 15 years ago, Mary Peters, Administrator at the Federal Highway Administration testified before the Senate Finance Committee that “Evasion of fuel taxes represents a significant loss of funding to every State, not just to those States in which the evasion occurs, since each State receives a share of every Federal-aid highway dollar. Loss of motor fuel taxes poses a serious threat to both Federal and State programs.” There is no reason to believe this threat has subsided in 2017.
Due to the intricacies of fraud, estimates of the amounts federal, state, county and even city governments lose are hard to pin down, past and present. A 1992 Federal Highway Administration study indicated that “the evasion rate for the federal gasoline tax was estimated to be between 3 and 7 percent and the diesel tax evasion rate was estimated at 15 to 25 percent” which amounted to about $3 billion annually, in 1992, for fed tax losses alone. In 2017 dollars, that’s $5.25 billion.
A 2001 study done by an independent analyst estimated that “potential revenue loss from jet fuel diversion alone [for direct use in diesel applications] could range as high as $9.2 billion for the FY 2002 through FY 2011 period.”
In conjunction with a federal study, Battelle performed a 2006 study for the State of Montana in which a cost estimate of losses was provided. For the country’s seventh least populated state, fuel tax losses in 2004 totaled $14 million, or 16.3% of all diesel sales and 2.1% of all regular gasoline sales. The study focused on Montana’s high diesel fuel tax rate and its southern neighbor, Wyoming, which has one of the lowest diesel tax rates in the nation. Battelle discovered an interesting “pointer” to potential cross-border bootlegging in that “Wyoming’s per capita diesel consumption is more than 700 gallons - Roughly four times the national average - More than twice that of any other state in the nation.” These numbers were determined by measuring sales from Wyoming’s terminal racks. Though not a smoking gun, such numbers are telling. Either Wyoming drivers of diesel fuel vehicles are led-foots with a penchant for travel, or a lot of Wyoming’s diesel fuel is ending up in other states.
The study found that during a 16 day “Joint border project conducted in 1996,” $1.4 million in assessments, or some $86,609 per day in unreported/misreported fuels were discovered during “1,188 commercial motor vehicle inspections.” Violations discovered during this sting found that 61% of tankers checked committed dyed fuel violations. Further, “BOLs (Bills of Lading) pulled on-road for Montana-bound Wyoming tankers yield unusually high diversion rates.”
But the worst estimate is from the most recent assessment from the U.S. Department of Transportation. It estimated that in 2014, one single year, “loss of revenue due to tax evasion… was from $1 billion to as much as 25% of total revenues” ($20 billion). These wild and wide ranging estimates, according to the Battelle study, are because “Historically, reliable estimates for motor fuel tax evasion rates and other highway user taxes have not been achievable.” But when considering how easy it is to defraud a government of fuel taxes and the potential net revenues from even minimal fraud, it is assumed that governments are likely losing on the high end of estimates.
Prevention Current Efforts
The current efforts in identifying and stopping fuel tax evasion are through on-highway enforcement, data reporting and analysis of fuel tax data, and pointed investigation into tips given to enforcement agencies. These efforts are not only time consuming and costly, but they often yield little in comparison to what is likely being missed. Further, in nearly all cases, the fraud has already taken place and the money lost.
Fuel tracking through the distribution chain via electronic monitoring does take place. The Excise Summary Terminal Activity Reporting System (ExSTARS) developed in 1998 and completed in 2002 tracks the movement of petroleum and petroleum products through state level terminals. But as shown in other articles in this issue of Energy Ink, once fuel leaves the terminal it is subject to a variety of methods to obscure its real destination and real end use. From the Battelle study, “it should be noted that while ExSTARS provides data on destination states for fuel leaving terminals, it does not supply exact destination location within states.”
Other methods Some refiners and terminals who want to ensure their branded products are reaching their intended destination have turned to fuel marking systems where chemical markers are added to a fuel which can be tested later at a retail outlet to determine its authenticity. This system is effective, but serves as an added cost per gallon to companies wanting to ensure their product is being sold at desired outlets.
Additionally, inventory control for many retail outlets still utilizes old, or no technology. Though some retailers have upgraded to digital measuring devices, “sticking” is still the standard. The sticking method is where gas inventory is determined with a long measuring stick placed into the underground storage tank. Retailers are only required to measure to within the nearest 1/8th of an inch, leaving even the most accurate “sticking” measurement off by as many as 13.25 gallons. Less accurate measurement can miss dozens of gallons where a distributor can easily short a retailer on each delivery.
The current effort at curtailing fuel tax fraud is somewhat troubling. Some states are seriously considering the application of digital metering devices in citizen’s vehicles and truck driver’s rigs to measure actual mileage travelled in a year for the purpose of applying a direct tax to the end user. This trend is referred to as a vehicle miles traveled tax, or VMT tax. A VMT fee currently “exists as part of a limited program for 5,000 volunteers in Oregon and for trucks in Illinois,” according to Wikipedia. This type of taxation is vehemently opposed by the trucking industry which fears such a development could destroy smaller carriers and cripple the industry as a whole. While eight states are considering legislation to study a VMT program, citizens fear a breach in privacy if devices are placed in every vehicle which can track mileage of the driver. Further, a nationwide VMT solution may be cost-ineffective when considering the price tag of millions of in-vehicle meters and monitoring.
The Disease of Fuel Tax Evasion
Fuel tax evasion is like an obscure disease infecting governments’ ability to ensure tax dollars are being collected and returned to the public in critical road infrastructure spending. Like a hard to identify disease, governments know they are infected, and are very aware of its physical effects, but they can’t seem to determine how widespread in the bureaucratic body it is, nor how to cure it. Though some unique and potentially effective solutions have been proposed, it seems such solutions are either politically unpopular or simply too costly. To fight the disease of FTE, an attitude akin to fighting human diseases must be approached in that bold innovation and perhaps some risk taking need to be employed. If nothing is done, then the patient, being that of our roadway infrastructure, and the funding that feeds it, will continue to worsen, and one day, perhaps, suffer the trauma of death by broken pavement and collapsing bridges.