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Federal Highway Administration > Publications > Public Roads > Vol. 69 · No. 3 > The Future of Highway Financing

Nov/Dec 2005
Vol. 69 · No. 3

Publication Number: FHWA-HRT-05-001

The Future of Highway Financing

by Jim March

Innovative Financing Series: Article 3

FHWA convened a roundtable of transportation finance and policy experts to discuss highway financing options.

Investment requirements to maintain the condition and performance of the Nation's highways, such as this one near Long Beach Harbor, CA, exceed projected revenues from current sources.
Investment requirements to maintain the condition and performance of the Nation's highways, such as this one near Long Beach Harbor, CA, exceed projected revenues from current sources.
Photo: Scott McKenzie, Caltrans.

Where will the dollars come from? Concerns about the adequacy of revenues from fuel taxes and the indirect link between fuel taxes and specific improvements to highways are leading highway administrators to reexamine long-term options for highway financing. For example, efficient pricing is one solution that may reduce congestion without requiring expensive new highway capacity; however, it "rocks the boat" in terms of existing methods of doing highway business. Exploration of alternatives can raise a number of economic, technological, equity, privacy, and public policy issues.

To discuss some of these key issues, their implications for the future, and options for highway finance, on May 21, 2004, former Federal Highway Administrator Mary E. Peters convened an informal roundtable titled "Future Highway Finance Issues and Options." The roundtable included 22 participants representing the Federal Highway Administration (FHWA), U.S. Department of Transportation (USDOT), American Association of State Highway and Transportation Officials (AASHTO), Transportation Research Board (TRB), and private consultants with expertise in highway finance. The goal was to further the dialogue on the need to explore financing alternatives, but not to come to a consensus on any of the issues or to draw conclusions concerning the most promising financing options.

In laying the framework for the roundtable discussion, former Administrator Peters said, "States face many challenges as they examine new ways to finance their highway systems, including planning for major projects, assessing the long-term viability and stability of new revenue sources, developing implementation strategies for new financing methods, and identifying winners and losers for alternative financing strategies."

Highway Pricing

Much of the roundtable discussion concerned the relative merits of moving toward greater use of pricing to finance new highway capacity and manage demand. Economists have talked for many years about the benefits of more efficient highway pricing-charging more for highway use during peak periods to reduce demand when strains on highway capacity are the greatest.

"Interest in the potential for peak period pricing to reduce highway congestion now is moving beyond the academics to highway administrators who see pricing as a way to reduce congestion without constructing costly new capacity," said FHWA Executive Director Frederick G. "Bud" Wright.

Background

For many years, fuel taxes and other revenues from highway users levied by the Federal Government and States have been a primary source of funds for Federal and State highway programs. A relatively small number of counties and municipalities also levy fuel taxes to finance highway improvements, but these local governments rely primarily on general funds, property taxes, sales taxes, and other revenues unrelated to highway users to finance local road and street construction, maintenance, and operation.

Historically, States and the Federal Government have viewed fuel taxes as an attractive revenue source for highway construction and maintenance programs for several reasons. First, the revenues from fuel taxes are linked, although imperfectly, with highway use. In addition, fuel tax revenues historically have been relatively stable and predictable. Legislators and/or the electorate have been willing to increase the fuel tax rates when necessary to meet highway improvement needs. Fuel taxes are attractive revenue sources also because costs to administer the programs to collect fuel taxes are low. Finally, fuel tax revenues in most States and from the Federal Government are dedicated at least in part for highways and related purposes, shielding the funds from the uncertainties of annual budgetary processes.

In recent years, several of these factors have undergone a change, leading many in the transportation community to conclude that alternatives to the fuel tax may be needed to fund future highway programs. One development is the growing disparity in vehicle fuel economy, which tends to make the fuel tax less equitable. The relationship between highway use and fuel tax payments is not as direct as it used to be. Another factor is that future vehicle fuel economy is predicted to increase, thereby reducing fuel tax revenues for each mile of travel.

In addition, legislators and the electorate in many States have been increasingly reluctant to approve increases in the fuel taxes. Opposition to raising taxes of any kind is increasing, and raising the fuel tax in particular has been difficult because of the growing disconnect in the view of many motorists between increased fuel taxes and observable improvements in highway condition and performance.

Some jurisdictions have chosen other alternatives to increasing fuel taxes, such as sales and other local option taxes. Martin Wachs, director of the Institute of Transportation Studies at the University of California, Berkeley, indicated that "more than one third of highway funding in California is from local option taxes."

Still another indication that new revenue sources may be needed is that fuel taxes do not automatically increase with rising highway construction costs. With a diminished ability to increase overall fuel tax rates, the revenues are not keeping pace with rising construction costs.

Technological improvements such as open-road tolling now make pricing a more feasible option for addressing congestion, and motorists in highly congested urban areas, such as Washington, DC, are beginning to consider pricing as a potential alternative to relieve congestion. In the near term it is unlikely that many U.S. cities will implement areawide pricing as has been done in some European and Asian cities. More likely, only parts of the network will be priced so that motorists have the choice of paying a toll to travel on uncongested roads or not paying a toll to travel on congested roads. Roundtable participant Robert D. Atkinson, vice president of the Progressive Policy Institute, noted, "We have failed over the past 15 years to provide choices that American motorists want."

The Federal Role in Highway Finance

During the roundtable, the discussion also focused on the Federal role in financing highway improvements. Participants generally were very supportive of the flexibility that was given to State and local transportation agencies to identify and fund transportation improvements that meet their unique needs. Former Administrator Peters emphasized that a strong Federal role may be necessary in certain areas, including "interstate and international commerce, safety, national defense and security, research and standards development, and provision of roads on Federal lands." She summarized, "A clear understanding of the Federal Government's interests in those program areas is necessary to evaluate its future role in highway finance."

A trend in recent reauthorization acts is an increase in the amount of Federal funds earmarked to specific projects by members of the U.S. Congress, and the latest Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy for Users (SAFETEA-LU) is no exception. This earmarking affects the ability of States to meet State and Federal priorities, and the trend has implications for future highway financing. For a number of years, some transportation policy analysts have maintained that part of the Federal highway program should be devolved to the States. However, there are constraints on the extent to which the Federal highway program can be devolved. Roundtable participants pointed out that a reduction in Federal tax rates would make it difficult politically for States to increase their tax rates to generate the same levels of revenue. Also, needs and revenue-raising capabilities differ dramatically among the States. Sparsely populated States may not be able to fund improvements to routes essential for interstate commerce and may require more funding than can be generated by motorists in those States.

Using value pricing on selected existing or new highway facilities could provide motorists in many cities with an alternative to sitting in traffic congestion like this four-lane gridlock.
Using value pricing on selected existing or new highway facilities could provide motorists in many cities with an alternative to sitting in traffic congestion like this four-lane gridlock.

The Federal role in any transition to alternative highway revenue sources also was discussed at the roundtable. As highway agencies move toward new funding mechanisms, one option mentioned would be to have the Federal Government collect the highway taxes and then redistribute them to the States. Administratively, this could save costs and reduce evasion, but States would insist on retaining their authority to set tax rates.

Another long-term model might be for one or more private-sector entities to collect taxes on behalf of Federal, State, and local government. Funds then could be credited to those units of government on the basis of their respective tax rates and the amount of travel in each jurisdiction. This option may have some of the administrative benefits of Federal tax collection but would not compromise the ability of State and local governments to independently adjust tax rates.

Fuel taxes supply 90 percent of the 2002 revenues to the Highway Trust Fund, with taxes on tires, truck sales, and heavy vehicle use together accounting for only 10 percent.
Fuel taxes supply 90 percent of the 2002 revenues to the Highway Trust Fund, with taxes on tires, truck sales, and heavy vehicle use together accounting for only 10 percent. Source: FHWA.

State fuel taxes and local taxes and fees account for 35 and 45 percent of State and local highway revenues, respectively, while tolls and other State highway use taxes comprise the remaining 20 percent.
State fuel taxes and local taxes and fees account for 35 and 45 percent of State and local highway revenues, respectively, while tolls and other State highway use taxes comprise the remaining 20 percent. Source: FHWA.

The Federal role in helping to facilitate the transition from reliance on fuel taxes to greater use of direct user charges would be to promote standards for transponders and tax collection mechanisms. The roundtable participants did not suggest that the Federal Government attempt to impose a single financing mechanism on the States. FHWA Associate Administrator for Policy Charles D. "Chip" Nottingham suggested, "States could test and evaluate a variety of potential financing mechanisms and choose the one or ones that best meet their needs."

The private sector also could play a role in developing innovative solutions to State financing requirements. Because States have quite different financing requirements and capabilities, future State financing structures may be no more uniform than current structures.

Property tax revenues could be a financial basis for local road construction around new highway interchanges like the Marquette Interchange in downtown Milwaukee, WI.  Increases in tax revenues from increased property values can be used to help finance highway construction.
Property tax revenues could be a financial basis for local road construction around new highway interchanges like the Marquette Interchange in downtown Milwaukee, WI (shown in this artist's rendering). Increases in tax revenues from increased property values can be used to help finance highway construction.

Another potential role mentioned for the Federal Government relates to the financing of megaprojects that have national or regional benefits and often cost more than a single State can afford. Examples include the Alameda Corridor in Los Angeles, CA; Chicago Regional Environmental and Transportation Efficiency Project (CREATE); port improvements; and other projects of national significance.

General Taxes

An important issue discussed during the roundtable and in the e-mail dialogue that preceded the meeting concerned the advantages and disadvantages of various types of revenue sources for highway expenditures. Included were user taxes, especially fuel taxes. Revenues to the Federal Highway Trust Fund currently come almost exclusively from highway user taxes. And 90 percent of those are fuel taxes.

Revenues for State highway programs also depend heavily on fuel taxes and other highway use taxes. But local governments tend to rely heavily on property taxes, sales taxes, and general funds as well to support their highway programs.

Most participants agreed that general taxes (property taxes, income taxes, and other general funds) are poor revenue sources to finance highway construction because they bear no direct relationship to highway use. Nevertheless, general taxes now represent about 25 percent of total revenues for highway purposes. About 75 percent of these general taxes are collected and expended for highways by local government agencies. Weaknesses of using general taxes for highways include the following:

  • Using general funds for highways draws those funds away from other programs that do not have potential direct revenue streams.
  • Because of long-term development associated with road building and the shifting priorities associated with general tax dollars, it is difficult to plan and contract for higher cost, long- term transportation projects.
  • Users generally are more receptive to paying charges that are tied to specific improvements.
  • General taxes do not reflect external costs associated with highway use, such as vehicle emissions that affect air quality, other environmental costs, and some safety costs.
  • Using general funds to supplement or replace user charges can lead to inefficient use of the highway system because general funds are not tied at all to highway system use.

To avoid such inefficiencies, an option would be for users to pay in proportion to their share of the costs of providing transportation facilities and services and the benefits they derive from using those facilities and services.

In general, the roundtable participants agreed that general taxes, especially property taxes, are more appropriate for funding local road improvements than for funding major State highway systems. The reason is that a primary function of local roads is to provide access to local properties, and local property owners are the major beneficiaries of that access. Highway improvements can increase property values, so there is some rationale for financing some local road improvements from property tax revenues. Many roundtable participants believed, however, that too large a revenue share for highways now comes from property and other general taxes.

Specialized Taxes

In recent years, local areas have begun to use specialized taxes, such as local sales taxes, special assessments, improvement district fees, and related taxes, to finance highway improvements. Although these specialized taxes suffer from the same problem as general taxes in that they are not directly related to highway use, the roundtable participants believed that specialized taxes may be a somewhat better option for financing highway improvements.

Local sales taxes are among the most popular of the specialized taxes. California, in particular, has made extensive use of local sales taxes to finance road improvements in recent years. Most jurisdictions require a referendum on whether to raise local sales taxes to finance a specific improvement or set of improvements.

Sales taxes and other specialized taxes work particularly well for such focused uses. Not only are they dedicated to specific projects, but local voters must approve the taxes and ultimately pay for the highway improvement--rather than using a general purpose tax that is paid by users from outside the region who do not benefit from the improvement. Less frequently, local sales taxes are simply tapped as an additional source of general funds for highway improvements.

In many States, the sales tax has become the most politically feasible option for local areas looking to finance major new transportation initiatives. The reason is simple, according to a study, Local Option Transportation Taxes in the United States, for the Institute of Transportation Studies at the University of California, Berkeley: More than for any other tax option, taxpayers have been willing to approve sales taxes on a scale that makes major new infrastructure projects possible. One explanation appears to be the dedication of revenues for specified improvements.

Sales taxes collected at stores like this one are among the more popular taxes for financing highway improvements in California.
Sales taxes collected at stores like this one are among the more popular taxes for financing highway improvements in California.

"Another factor that makes the local sales tax attractive to the electorate is that the tax has such a wide base," said roundtable participant Susan J. Binder, director of the FHWA Office of Legislation and Strategic Planning. "A small increment in the tax rate is barely perceived on individual purchases, but when applied to a large number of items, it can generate substantial revenues."

Fees on new development, such as the new townhouses shown here, adjacent to highway improvements can provide substantial revenues to help fund improvement costs.
Fees on new development, such as the new townhouses shown here, adjacent to highway improvements can provide substantial revenues to help fund improvement costs.

Another specialized tax that has been used to finance highway improvements is the developer fee. "Many believe that it may be appropriate to require developers to pay at least part of the cost of providing local roads that serve their developments," said roundtable participant David J. Forkenbrock, director of the Public Policy Center at the University of Iowa.

Ultimately these developer fees are passed on to the households and businesses that purchase property in the development. This option is similar to tax increment financing where increases in property values are tapped to pay for part of the cost of road improvements.

Tolls and other direct user charges will be increasingly important sources for funding major bridge, tunnel, and roadway facilities, like this tunnel at the Canadian border.
Tolls and other direct user charges will be increasingly important sources for funding major bridge, tunnel, and roadway facilities, like this tunnel at the Canadian border.

Another related specialized tax is an improvement district fee. This alternative is especially useful for transportation improvements that traverse taxing districts because the improvement district can be defined to encompass whatever area is deemed to benefit from the transportation improvement. Within this category of taxes, several different specific types of taxes could be levied. The objective would be to have those users and property owners who benefit from the transportation improvement pay the cost. This option may be especially applicable to megaprojects, because they often cross jurisdictional boundaries.

Direct User Charges

Most of the roundtable participants believed that highway financing should move toward greater use of direct user fees, such as tolls or mileage-based taxes. The advantage of direct user charges is that rates can be set to better reflect the costs associated with the use of highway facilities.

There was less agreement about which costs should be reflected in direct user charges. At present, many toll authorities set toll rates at levels sufficient to generate revenues to pay off bonds issued to construct the toll road; to pay maintenance, operating, and administrative costs; and perhaps to provide a sinking fund for future rehabilitation and enhancements.

In some cases, tolls on highways and bridges are continued after the bonds have been paid off, and the revenues are used to subsidize other transportation improvements. In these cases, overall tolls may be higher than the cost of constructing and operating the toll road.

Recently, interest in value pricing has been increasing, enabling toll rates to be higher during peak than offpeak periods. In these cases, the tolls are intended to reflect the benefits of traveling in less congested conditions, not the cost of constructing, operating, and maintaining the facility.

There was some discussion about the fact that different users impose different costs upon the system. Heavy trucks, for instance, cause greater pavement and bridge wear and contribute more to congestion than do automobiles, so the participants believed that it is appropriate to charge higher rates for trucks. Toll authorities do charge trucks higher tolls than passenger vehicles, but toll structures generally do not reflect a formal estimate of the relative costs associated with the operation of different types of vehicles.

Several potential impediments to direct user charges were discussed. First, administration and collection costs are higher for direct user charges than for fuel taxes. With direct user charges, each driver generally would be responsible for paying charges they owe to tax collection agencies. However, when drivers purchase fuel, Federal and State taxes have already been paid by companies further up the fuel distribution chain. Fewer taxpayers means that collection, enforcement, and other administrative costs would be lower for fuel tax collection agencies than for agencies responsible for collecting direct user charge payments.

Second, fully implementing direct user charges could take considerable time. In certain congested metropolitan areas--such as Orlando, FL, and Dallas, TX--users have demonstrated an increasing willingness to pay tolls for added capacity, particularly where they also receive improved levels of service. But other users generally have not favored tolls.

Third, where variable tolls are charged to maintain free-flowing traffic, the tolled lanes are widely regarded as "Lexus Lanes" out of concern that they benefit the wealthy more than other socioeconomic groups. According to a California Department of Transportation report, Continuation Study to Evaluate the Impacts of the SR 91 Value-Priced Express Lanes, actual experience has demonstrated that users come from all income levels.

Fourth, users have resisted tolling existing lanes. One reason for this is that users believe they have already paid for the existing facilities and should not be charged twice.

Fifth, it may be difficult to operate a toll facility when there is a mature system of free roads available to potential users. Where the toll facility is priced to maintain free-flow operations, users will pay when the free roads are congested, but during offpeak periods when the free roads are uncongested, few motorists may be willing to pay to use the toll facility.

A factor reflecting all of these impediments is an apparent reluctance on the part of politicians to propose or support tolls because of uncertainties about how the electorate will react.

The trucking industry has much to gain if highway performance can be improved, but the industry generally has opposed tolls. Some portions of the trucking industry have indicated that they might support tolls if more productive vehicles were allowed on the toll roads. A recent study by the Reason Foundation, Corridors for Truck Tollways: Suggested Locations for Pilot Projects, concluded that exclusive toll roads for trucks might be feasible in a number of corridors.

Despite uncertainties about how quickly direct user charges can be implemented, former Administrator Peters emphasized during the roundtable that transportation agencies should not be timid about implementing this option. "The benefits in terms of more efficient use of roadways through pricing and direct user fees that will help raise revenues needed to improve our Nation's highway system are too great to delay implementation of these tools," she said.

One thing that could help expedite implementation of direct user charges is a defined implementation path for moving forward. Currently, States are implementing direct user charges on an ad hoc basis, although the Federal Value Pricing Pilot Program has encouraged a number of areas to investigate different types of pricing options. Studies of high-occupancy toll (HOT) lanes are underway on I-15 in San Diego, CA, and I-10 and U.S. 290 in Houston, TX. And researchers are looking at express lanes on S.R. 91 and peak pricing on the San Joaquin Hills Toll Road, both in Orange County, CA.

Studies Underway Or Planned

Several initiatives already are underway to begin exploring future highway financing issues and options. To describe the current policy framework for transportation finance and evaluate options for a long-term transition to sources other than fuel taxes, TRB, FHWA, and the National Cooperative Highway Research Program cosponsored a study, Long-Term Viability of Fuel Taxes for Transportation Finance. The report is scheduled for publication in January 2006. Specific goals are the following: (1) Determine the extent to which alternatives to fuel taxes will be needed in the next two decades; (2) Analyze the pros and cons of different alternatives; (3) Suggest ways in which barriers to these alternatives might be overcome; (4) Recommend steps for enhancing the efficiency and fairness of the fuel tax; and (5) Recommend, as necessary, a transition strategy to other revenue sources.

Fifteen States and FHWA participated in a pooled fund study, A New Approach to Assessing Road User Charges, published by the University of Iowa Public Policy Center (www.ppc.uiowa.edu), to design a mileage-based road user charge. This alternative approach to assessing road user charges would utilize new technology that is currently available and expected to be widely available in the future. A major part of the study involved assessing various institutional barriers such as privacy concerns and public acceptance that would have to be overcome before this new revenue mechanism could be implemented. Recognizing the many technological and public acceptance issues that would need to be overcome, the study recommended a thorough field test and evaluation of the financing method. A large-scale test of this revenue mechanism was called for in Section 1919 of the SAFETEA-LU.

Under the Value Pricing Pilot Program, Oregon plans to test a mileage-based highway financing method that would replace the fuel tax if implemented. The mileage-based method differs in detail from the one analyzed in the pooled fund study noted above, but it also has some common elements.

Conclusions

The fuel tax has provided a stable revenue source that has enabled the United States to construct the finest highway system in the world. However, a number of groups are questioning the long-term viability of the fuel tax to finance future expansion, maintenance, and operation of that system and are examining alternative mechanisms to fund future improvements to the highway system.

Technology will introduce a much broader range of options than could have been considered 10 years ago, but technological issues are perhaps the easiest to address. There will be winners and losers with any new tax mechanism, and nontechnical issues like privacy and public acceptance will be critical in developing revenue alternatives.

The transition path to new mechanisms is not clear, and it likely will vary among different jurisdictions. What is clear is that developing a consensus on alternative approaches will take considerable time and public involvement. Fortunately, alternatives do not have to be implemented immediately, but most transportation finance professionals participating in the roundtable indicated that the transportation community should not postpone addressing the many issues facing Federal, State, and local governments as they look toward how to finance future highway transportation programs.


Jim March is leader of the Industry and Economic Analysis Team in FHWA's Office of Policy. He manages a multidisciplinary team of economists, engineers, and transportation specialists who conduct a broad variety of transportation policy studies on topics such as public-private partnerships, highway finance, highway cost allocation, the Federal role in surface transportation, strategic multimodal freight analysis, and impacts of highways on economic productivity.

For more information, contact Jim March at jim.march@fhwa.dot.gov or 202-366-9237.

This article is the third in a series on innovative financing that will continue to run in the next few issues of PUBLIC ROADS. One of FHWA's priorities is encouraging the use of innovative financing.

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