Maryland Governor O’Malley Takes a Risk on Gas Tax

By: - February 10, 2012 12:00 am

Tom Williams/Roll Call
Maryland Governor Martin O’Malley is proposing to tie the state’s gasoline tax rate to the price of the product, rather than the amount a consumer buys. Motorists would likely pay more over time.

With gasoline near $3.50 a gallon and the economy still fragile, Maryland Governor Martin O’Malley realized he was in for a struggle this year when he proposed raising taxes on gas to pay for transportation spending. “I know this is a very, very difficult ask,” O’Malley said in his state of the state speech last month. Perhaps with that in mind, O’Malley designed his plan to make it less likely that future governors will need to ask again.

Rather than recommending an increase in the existing gas tax, O’Malley proposed that the state’s regular 6 percent sales tax apply to gas. That means that the amount of revenue the state brings in for each gallon of gas consumers buy would change with the price of the product. If the price went down, the tax would go down. More likely, though, prices will eventually go up and the tax would go up with them.

That’s not the way gas taxes usually work. Most of them are based simply on the number of gallons purchased. But cars are becoming more fuel efficient, so people are buying less gasoline and paying less tax. Just as important, inflation has reduced the value of cents-per-gallon gas taxes over time, even as the rates have often remained unchanged. The result of all this is that lots of states face shortfalls in paying for road maintenance and construction.

Maryland’s regular gas tax has been 23.5 cents per gallon since the days of dollar-a-gallon gas, while the cost of transportation projects and maintenance has grown dramatically. That was one of the reasons the Maryland Blue Ribbon Commission on Transportation Funding, a task force created by the legislature, recommended last year that the state seek an additional $870 million a year in tax revenue. “The last time the gas tax increased was 20 years ago and there was no indexing,” says Gus Bauman, a lawyer who chaired the Blue Ribbon Commission. “Now we’re in a giant hole with enormous needs and the gas tax is the same.”

Variable rates

Against that backdrop, a number of states have tried taxes on gas that grow automatically with higher prices. As in Maryland, these taxes usually are designed to solve a budget problem: States want more money for transportation. Just as much, though, they’re designed to solve a political problem: Gas tax increases are unpopular, so legislators want to vote for them as infrequently as possible.

Variable-rate gas taxes have had some success in achieving both those objectives. States that have them tend to collect more money, since not every increase in the tax takes a vote of the legislature. What these states have also learned, though, is that even ostensibly automatic gas tax increases are controversial. Often, lawmakers feel pressure to stop them, even if the only thing that needs to happen for an increase to go into effect is for elected officials to do nothing at all.

The idea of a variable-rate gas tax goes back several decades. In the 1970s and early 1980s, many states adopted gas taxes that were tied to the price of fuel. When price inflation ebbed and gas prices crashed in the 1980s, these states were burned. Several of them switched back to fixed rate per-gallon taxes, including Maryland.

Today, about 15 states have variable-rate gas taxes. These states differ in how their taxes are structured and the extent to which they allow the tax rate to change. Some, such as Illinois, Michigan and Indiana, apply their regular sales taxes to gas purchases, without even requiring that the proceeds be spent on transportation. Others, such as North Carolina and West Virginia, have gas tax rates that, in part, change with the price of fuel.

Volatile source

Despite the differences, though, states with variable-rate gas taxes generally have something in common: They collect more revenue. As of October, nine of the ten states with the highest gas taxes in the American Petroleum Institute’s rankings  – Connecticut, California, New York, Hawaii, Illinois, Michigan, Indiana, North Carolina and Florida — were using some form of variable rate. Their gas taxes have gone up without legislators having to vote. In North Carolina, for example, the gas tax has gone from 26.6 cents per gallon in 2005 to 38.9 cents per gallon today because of automatic increases.

North Carolina drivers, of course, may not be celebrating the success of the state’s gas tax. They face a double whammy: On top of higher gas prices, they’re also paying more in taxes. Even many supporters of variable-rate gas taxes think there are better ways to structure them than to connect them to the price of fuel. “Gas prices are tremendously volatile,” says Carl Davis, senior policy analyst with the left-leaning Institute on Taxation and Economic Policy. “You end up with wild swings in the tax rate.”

To get at that problem, states have limited the speed at which a variable-rate tax may rise or fall. O’Malley’s proposal will include such a mechanism. Florida adjusts its gas tax to overall inflation, which is far more stable than the price of gas. The method that Davis and some other experts prefer , though, is a gas tax that changes automatically based on what the tax is supposed to be paying for: the cost of transportation work.

No state currently indexes its gas tax to the cost of transportation projects, but Nebraska does something similar. In Nebraska, the legislature decides how much money the Department of Roads will receive. Then, if the state’s gas tax isn’t projected to bring in the budgeted amount of money, the rate automatically adjusts so that it will.

Not quite automatic

That system, however, hasn’t made Nebraska’s transportation funding problems go away. Instead, lawmakers have often limited appropriations for the Department of Roads, knowing that if they gave the agency too much money they would be responsible for a tax hike. “We probably only receive half of what we really need on an annual basis,” says Steve Maraman, finance administrator for the state’s Department of Roads.

That isn’t just Maraman’s judgment. It’s the judgment of the legislature too. Last year, in a controversial move, Nebraska lawmakers voted to redirect a portion of the state’s sales tax to transportation starting in 2013. In doing so, they were conceding that the gas tax wasn’t bringing in enough money to pay for what they wanted.

Likewise, systems for automatic rate increases haven’t removed the politics of the gas tax in other states. In fact, they’ve often yielded political debates whenever the rate is scheduled to change. Lately, in some of those debates, the public’s displeasure with gas tax hikes has been winning out.

In Georgia, Governor Nathan Deal used an executive order to block an “automatic” gas tax increase last summer. Between 2003 and 2011, Maine’s gas tax rose from 22 cents a gallon to 30 cents a gallon under a system that tied the tax to inflation, but newly empowered Republicans converted it back to a fixed-rate tax last year. In North Carolina, the House passed a bill to block the state’s automatic increase, but it died in the Senate. The issue could reemerge this year.

To supporters of higher gas taxes, though, those fights are still preferable to starting from scratch in the legislature each time the tax is falling short. Maryland will have a fight of robust proportions this year. Already, Senate President Thomas V. Mike Miller has  expressed doubts O’Malley’s proposal will pass. The Republican legislative minority has coalesced in opposition, and State Comptroller Peter Franchot — a Democrat, like O’Malley — has condemned the plan.

In Michigan, where Republican Governor Rick Snyder also has endorsed a gas tax that would rise with the price of fuel, a major debate is underway. The state hasn’t touched its fixed-rate cents-per-gallon tax since 1997, when lawmakers increased it by four cents after a bruising debate. Supporters of the variable-rate tax hope to appeal to lawmakers on the grounds that they’ll be less likely to have to vote on gas tax increases again soon — even if the issue never totally goes away. “It’s taken 15 years to get back to this discussion,” says state Representative Rick Olson. “This is obviously not a topic that elected officials will want to come back to.”  

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Josh Goodman

Josh Goodman helps lead research on fiscal management and place-based economic development programs as part of Pew’s state fiscal health project. Goodman has served as a primary author for Pew studies that examine how states should evaluate tax incentives and maintain budget discipline when implementing those incentives.