How should America fund its highways in the 21st century?

Falling gasoline prices have sparked a comeback among gas guzzlers, and the Obama administration wants to stop it in its tracks.

The White House last week proposed making crude oil more expensive by imposing a new tax of US$10 a barrel. The money would go toward improving the current highway infrastructure and invest in regional transportation systems to reduce road congestion and pollution.

The proposal comes just days after the average U.S. gasoline price fell below $2 per gallon for the first time since 2008.

Cheap gasoline raises the perennial question over how the U.S. funds its transportation infrastructure – a key rationale behind Obama’s proposed oil tax. And it makes electric vehicles (EVs) and biofuels less competitive on price, hindering U.S. efforts to reduce greenhouse gas emissions and oil consumption.

Can the U.S. continue to fund upkeep of its infrastructure and reduce emissions from transportation?

Less appeal to cleaner EVs

Consumers have a growing number of electric vehicles to choose from, but cheap gasoline means the payback period for electric vehicles – the time it takes to recoup the higher upfront cost in fuel – is now much longer than a few years ago, sometimes as long as 10 years. Consumers have responded by buying more gasoline and trading in their electric vehicles for SUVs.

Americans are also driving more and recently set a new record for miles driven, the first since 2007.

The big reductions to electric vehicle battery costs – considered a cost barrier to broader sales – seen in recent years have been overwhelmed by cheap gasoline. A McKinsey analysis calculates that electric vehicles are competitive with current gasoline prices only once current battery prices are cut in half – something that could take up to a decade. A tax on every gallon of gas or diesel funds highway upkeep – and cheap gas is leading to an increase in gas sales.viriyincy/flickr, CC BY-SA

Biofuels are also struggling to compete with inexpensive gasoline and diesel fuel.

The profit margins of biofuels are determined by the prices of their biomass feedstocks – whether it’s corn or sugar cane – and that of gasoline or diesel fuel. Fuel prices have fallen by a larger amount than feedstock prices have over the last year, causing biofuel profit margins to approach zero.

A ‘toll’ for highway funding

On the other hand, low gasoline prices are good news for the country’s national highway system, which received a “D” grade on the most recent Report Card for America’s Infrastructure. The federal fuel tax is applied to every gallon of gasoline sold rather than its price. Higher demand for and consumption of gasoline therefore should generate additional tax revenue.

The American Society of Civil Engineers calculates that $170 billion in annual investment is needed to “significantly improve” the country’s roads. Actual spending has not kept up and the Highway Trust Fund, which finances spending on national roadways, nearly went broke last year.

Funding for America’s interstate system has not met requirements in recent years because of the way its maintenance is funded. In 1956 Congress created excise taxes on gasoline and diesel fuel to finance highway construction.

Remember these days? Higher gas costs meant sales of more efficient vehicles – and less revenue for highway maintenance.altopower/flickr, CC BY-NC-ND

The fuel taxes, the revenues of which were (and still are) paid into the Highway Trust Fund, were considered to be more equitable than the previous method of funding highways with income tax revenues. The amount of income tax paid by a taxpayer is a function of overall income, meaning that highways were originally financed by the wealthiest Americans rather than by the drivers using them.

The fuel tax, on the other hand, is similar to a toll in that the individuals getting the most use out of the highways also contribute the most money to their upkeep.

The 1950s and ‘60s saw booming demand for gasoline as Americans bought more cars and spent more time driving. Those cars also achieved poor gas mileage, although drivers didn’t mind since gasoline was inexpensive. U.S. gasoline and diesel fuel consumption increased until 2008, and fuel tax revenues rose with it.

Meanwhile, the fuel tax has remained at $0.184 per gallon for gasoline and $0.244 per gallon for diesel fuel since 1993.

Dampening demand

In the mid- to late 2000s, gasoline prices rose and encouraged Americans to buy fuel-efficient vehicles. In parallel, the federal Corporate Average Fuel Economy (CAFE) standards have required them to increase the fuel mileage of their vehicles since the 1970s.

Also, younger drivers have opted to drive less, preferring to use mass transit or new ride-share programs. The total miles driven by Americans peaked in November 2007 as a result and then declined over the next several years.

The combination of less driving and improved fuel mileage caused gasoline consumption to also peak in 2007 (rapid ethanol consumption growth also contributed).

The CAFE standards have become more ambitious under the Obama administration, pushing the average mileage for cars and light trucks from 30 miles per gallon in 2012 to 49 miles per gallon in 2025.

This increase will cause the average greenhouse gas emissions of cars and light trucks to fall by 45 percent over the same period. However, improved fuel efficiency means lower fuel consumption. That reduces tax revenues for the Highway Trust Fund.

CAFE standards for combined cars and light trucks.Center for Climate and Energy Solutions

Fuel efficiency and highway upkeep

American policymakers have recognized that the CAFE standards cannot coexist with the current fuel taxes and have offered multiple proposals for fixing the dilemma. A rebound in oil prices next year, as some expect, could turn consumers to more efficient vehicles again, again cutting proceeds to the Highway Trust Fund.

The first proposal is to “top up” the Highway Trust Fund with income tax revenues, a short-term solution that has been resorted to in the past and as recently as last July.

Another short-term solution proposed by the Obama administration would finance highway construction by requiring corporations to pay taxes on profits stored overseas. Both proposals are flawed in that they weaken the venerable connection between those paying for the highways and those using them.

A third proposal is to take advantage of low gasoline prices by increasing the fuel tax. To make this acceptable in a general election year, the increase would be offset by an income tax credit to make it revenue-neutral.

A major problem with the tax increase on fuel is that it wouldn’t reduce all crude oil consumption. Roughly two-thirds of every barrel that is refined produces gasoline and diesel fuel. The rest is refined into everyday products such as jet fuel, commodity chemicals and asphalt. Raising the fuel tax doesn’t discourage the consumption of these other fossil fuel products as a result.

The White House’s $10 tax on every barrel of crude oil used in the U.S. would have a similar effect to a higher fuel tax by discouraging gas guzzlers. And it would create a greater financial incentive for green alternatives to petroleum-based products, such as development of renewable plastics and biobased asphalt. The proceeds of the tax would also fund necessary investments in the transportation system.

But the crude oil tax proposal faces strong opposition in Congress and has no chance of becoming law before November’s general election. Despite this, the debate over it that will follow in the coming weeks will illustrate the importance of finding new ways of funding America’s highways in the 21st century.

It’s also a reminder of the steep challenge of funding our transportation infrastructure in a way that both political parties can agree on.

Tristan R. Brown owns a diverse portfolio of shares in energy production companies.