Highway Finance: Past, Present, and Future

by Germaine Williams and Tom Howard

Introduction

The current finance structure for highways is not producing the funds needed to meet the country's requirements for highway investment. Evidence for this is found by comparing recent trends in highway finance and the annual investment required to maintain the current level of highway system performance. Any adjustments to the existing financing structure should be based on a systematic re-evaluation of all available highway finance options.

Recent Trends in Highway Financing

In 1991, all levels of government combined spent $74.9 billion to construct, maintain, and operate the U.S. highway system. To put this into perspective, direct outlays for transportation by passenger and freight users of the transportation system were $969 billion in 1990. (See figure 1.) Of this, the direct outlays of highway users--including vehicle costs and operating expenses for private automobiles, bus and transit, taxis, and trucks--were estimated at $828 billion.

Funding for highways comes from all levels of government. In 1991, the state and local levels of government provided 78 percent of all funding for highways and 59 percent of the funding for capital outlays, with the federal government providing the remaining funds, almost exclusively for capital.

The following highlights characterize 1991 highway finance sources and trends (see figure 2):

• The largest source of these revenues was motor fuel and vehicle taxes; these provided $47.2 billion, which was 57 percent of total 1991 revenues.
• Tolls, the other major component of what are generally referred to as highway user charges, accounted for $3.1 billion in revenue (4 percent).
• General fund appropriations, benefit charges, and investment income together provided $25.1 billion (31 percent).
• Bond issue proceeds accounted for $6.9 billion (8 percent).

A more historical perspective is reflected in the following points:

• The share of revenues provided by the different funding sources of finance has varied little over the past 10 years as motor-fuel and vehicle taxes have maintained their position as the single largest source and tolls, other sources, investment income, and bonds have not varied significantly during that time period.
• Since 1981, spending has been almost evenly divided between capital improvements and noncapital maintenance and operation items. (See figure 3.)

How Much Additional Funding Is Needed?

Based on estimates published in the 1993 Conditions and Performance Report, $51.6 billion need to be invested annually for the next 20 years to maintain the current conditions and performance of the highway infrastructure. This, however, is only part of the picture. Investment estimates in the Conditions and Performance Report include only those capital investments related to the physical condition of roads and bridges, and it contains no estimate of noncapital spending requirements.

If it is assumed that the level of expenditure for off-road capital and noncapital highway spending should be at least comparable to their 1991 level for the next 20 years, an additional $42 billion in 1991 dollars should be added to the annual investment needed over the next 20 years. This is a conservative assumption since maintenance expenses tend to increase as the system ages, and the Conditions and Performance Report's estimated investment requirements for highway and bridge capital improvements assume that some of the demand for increased highway capacity will be met by improved management of the system, i.e., transportation demand management.</<br>

The combined total of capital and noncapital spending required to maintain conditions and performance at their 1991 level--$93.6 billion--is $19.1 billion more than was actually spent in 1991. To continuing to maintain the 1991 level of support for the highway system and to provide the increase in funding needed to actually maintain the current level of performance, the current level of funding--$74.5 billion--will need to increase annually to keep up with inflation, and an additional $19.1 billion in real dollars is needed every year to raise the annual expenditure to the level needed to prevent further deterioration in system performance.

Table 1 -- Highway revenue sources, 1991

Grand total receipts: $82.4 billion

Options for Increasing Highway Revenues

The above argues that the current highway financing system is not sufficient to meet current requirements and that it is necessary to systematically examine all possible options to meet this financial shortfall. The range of possible revenue sources can be grouped as follows:

• Increase highway user revenues.
• Increase other taxes and benefit fees.
• Make fullest use of investment income and other receipts.
• Increase bond issue proceeds.
• Enhance private sources.
• Develop and use other financing innovations.

Increase highway user revenues

Highway user revenues comprise more than 60 percent of total highway revenues. In 1991, these fees accounted for more than $50.3 billion of the $82.4 billion raised for highways. (See Table 1.) These receipts were collected at the federal, state, and local levels.

The overwhelming majority of all highway user revenues (94 percent, or $47.2 billion, in 1991) are raised from motor fuel taxes. About $3.1 billion, or 6 percent, of highway user revenues were derived from tolls in 1991.

Increasing these highway user charges represents one option for increasing highway financing. For example, federal legislation enacted in 1993 will redirect 2.5 cents of federal motor fuel taxes from deficit reduction to surface transportation use beginning in 1995. Also, 17 states increased their gasoline tax rates, and 16 states increased diesel fuel tax rates in 1993.

Most agree that user taxes are the fairest taxes because the consumer pays for use. However, as previously noted, the highway user tax base has not been producing revenue increases quickly enough.

Increase other taxes and fees

In 1991, other taxes and fees comprised about $19.1 billion, or 23 percent, of highway receipts. These revenues were collected from property assessments, general fund appropriations, and other taxes and fees.

Property taxes and assessments, which are collected exclusively at the local level, totaled $4.5 billion in 1991. Federal general funds primarily represent non-Highway Trust funds appropriated by Congress to the Federal Highway Administration (FHWA) and other federal agencies. State and local general funds include appropriations from state and local governments to transportation agencies. In 1991, $12.0 billion was raised from federal, state, and local general fund appropriations. Other taxes and fees accounted for the remaining $2.7 billion of these revenues; these are collected primarily at the state and local levels and consist of taxes on severance, personal property, income, and sales.

These revenue instruments are used primarily at the local level for raising revenue. However, taxpayers have resisted increases in property taxes, even though the demand for local government services has also increased. This pressure may limit the potential for property tax increases to finance highway improvements.

The income resulting from these investments and receipts is available as an additional source of funds. The Federal Highway Trust Fund is an example of such a source. In 1991, the Highway Account of the Highway Trust Fund realized $0.8 billion from its investments.

The use of investment income represents another option for increasing highway financing. While investment income is important, several factors limit its potential as a major highway revenue option. Decreases in interest rates and the declining balances on which interest is earned are among those factors that reduce investment income.

Bond issuance may be further increased by federal backing of state and local highway issuances. For example, Vice President Gore's National Performance Review calls for a change to current law that would allow states to use their federal funds as capital reserves to back debt financing. (2) These credit-enhancing capital reserves potentially increase issuers' bond ratings and reduce borrowing costs. Private bond insurance, which guarantees lenders and bond-holders that they will be repaid in the event of default by the issuing authority, is now used by many state and local issuers of highway bonds to reduce interest costs.

Although increased issuance of state and local bonds would enhance current revenues, this debt would have to be paid off eventually. Revenue streams commonly used to pay off or guarantee debt are toll user fees, fuel taxes, state general funds, and income taxes. Currently, outstanding state and local obligations for highway debt are about $47.9 billion.

Develop and use other financing innovations

This category includes all other means of increasing highway financing not included above, or other institutional approaches to financing that make use of the above sources--for example, the creation of state revolving funds, which could recycle highway dollars. These revolving funds provide loans to highway entities for highway projects. The repayment of these loans over time allows the fund to revolve its lending ability in perpetuity. For example, the Washington State Public Works Trust Fund, established in 1985, was developed to provide a dependable long-term source of funds to local governments for infrastructure repair and reconstruction.

Reducing highway tax evasion is another means of increasing program receipts. Recent federal legislation requires tax-exempt diesel fuel to be dyed and raises the point of diesel fuel taxation to the terminal level. This legislation will have a positive impact on reducing the $2 billion annual state and federal fuel tax evasion loss.

More extensive use of revolving funds, administrative improvements to reduce evasion, and other institutional approaches comprise a final option for increasing highway finances.

How to Pay for $25 Billion More in Highway Projects

Highway user fees represent a strong potential source for addressing unmet highway financing requirements. Following are two of many possible scenarios for using these fees. These scenarios have been intentionally simplified.

Assumptions

• The increased motor fuel taxes scenario assumes: (1) that only motor fuel taxes would be increased and (2) that the increased cost of motor fuel would not reduce consumption.
• The increased bond issuance scenario assumes: (1) that all revenues would be raised through the issuance of bonds, (2) that all bond proceeds are available to meet highway needs, and (3) that borrowing is at 6 percent annually.
• Both scenarios assume: (1) a 20-year time horizon and (2) that spending should be increased by $25 billion annually. (This is about halfway between the $16.1 billion needed to maintain 1991 conditions/performance and the $30.6 billion needed to improve conditions by eliminating the backlog and addressing accruing needs.)

Increased Motor Fuel Taxes Scenario

Motor fuel taxes would need to be raised by slightly less than 20 cents per gallon in order to increase highway spending by $25 billion annually. This figure is based on the rule of thumb that a one-cent per gallon increase in motor fuel taxes would equate to about $1.3 billion in new revenues per year. These new taxes would increase the cost of travel, which is currently about 3.4 cents per mile, by a little more than one cent per mile. At end of the 20-year period, the increased taxes could be re-examined to determine if highway conditions had improved sufficiently to allow a tax reduction or elimination.

Increased Bond Issuance Scenario

To increase highway spending $25 billion annually through increased municipal bond issuance would incur only very small interest payment charges in the scenario's early years. As little as $1.5 billion in the first year would be needed to pay bond interest. However, because it is necessary to issue $25 million in bonds annually, these interest costs would accumulate. After 17 years, the cost of interest on the bonds would exceed $25 billion. The total debt after 20 years would be $500 billion. This total, when added to interest costs over the 20 years, would add over 20 cents per mile of travel to pay the debt incurred.

If toll revenues were used to pay interest on the bonds and retire the bonds when due, more than 2.5 cents per vehicle-mile traveled would be added to users' travel costs.

Conclusion

These scenarios provide two extreme examples and are intended to stimulate future policy discussion. Neither an immediate tax increase of slightly less than 20 cents per gallon nor a massive highway debt is an option that would totally fulfill the criteria outlined in the main article. However, these scenarios demonstrate the need to examine all policy and legislative options to increase highway spending.

Evaluating the Options

In general, revenue sources may be evaluated on their revenue potential (i.e., their ability to raise the needed resources); their equity (fairness of distribution of costs to benefits); their efficiency (which pertains to the ability of the government to collect these revenues); and their political acceptability to taxpayers and government decision makers.

One approach to increasing highway financing is to consider the relative merits of those highway revenue options that best meet the above criteria. Another approach to increasing highway financing is to assume that the "system is broken"--i.e., that the basic concepts of highway finance must be revisited and that a comprehensive change in the highway financing system is needed.

No matter what approach or strategy is chosen, highway financing requirements are almost overwhelming. Their magnitude requires transportation officials to look at every option and to carefully plan a strategy that will increase investment. No single option or strategy, however, is likely to solve the problem entirely at all levels.

FHWA Establishes Innovative Finance Test
and Evaluation Project

By a March 14, 1994, memorandum to FHWA regional administrators, Federal Highway Administrator Rodney E. Slater established "Innovative Financing" as Test and Evaluation Project, TE-045. Supporting and building on ISTEA legislation, the goal of the innovative financing project is to encourage states, private investors, and the financial community to increase investment in transportation. Under this initiative, barriers will be considered for removal on a test basis for future legislative or regulatory actions.

Under the test and evaluation projects approach, states identify specific projects, develop a plan of finance, and offer these projects as examples of creative financing solutions. Developing such examples is a key element of this proactive effort.

These test and evaluation projects are intended to advance innovative financing concepts which hold the most potential to increase investment or reduce public agency costs.

FHWA has general discretion to conduct financing research and development initiatives under Section 307(a) of Title 23 of the U.S. Code. Under test and evaluation projects, FHWA will make full use of ISTEA and Title 23 regulatory and statutory flexibility.

The proposals for experimental projects should describe the project specifics including funding.

The proposals must be for ISTEA-eligible projects; new construction and reconstruction projects are appropriate. Proposals will be evaluated based on criteria now being developed, which will include degree of financial leveraging, nature of innovation, and other proposal characteristics.

Upon acceptance of a state's proposal, the project will be advanced by the FHWA offices in a normal but expedited manner.

For more information, contact Jerry Poston, FHWA's Federal-Aid Program Branch chief at (202) 366-0450, or Bruce Cannon, chief of the Legislation and Strategic Planning Division at (202) 366-9208.

References

(1) The Status of the Nation's Highways, Bridges, and Transit: Conditions and Performance. Report to Congress, Publication No. FHWA-PL-93-, Federal Highway Administration, Washington, D.C., 1993.

(2) Al Gore. From Red Tape to Results: Creating a Government that Works Better and Costs Less, Report of the National Performance Review, Washington, D.C., Sept. 7, 1993.

(3) Transportation in America, Eno Foundation Inc., 1992.

Germaine Williams and Tom Howard are both transportation specialists in FHWA's Office of Policy, Legislation, and Strategic Planning Division. Both have worked extensively in the area of highway finance as well as other highway policy areas.