America's Gasoline Excise Tax: A Mighty Temptation

Updated April 2013

As we are all aware, a portion of what we pay at the pump is in the form of an excise tax that is collected by the refiner and remitted to more than one level of government.  Excise taxes are basically sales taxes levied on specific goods as either a percentage of the value of the good or as a set dollar value per unit of the good as in the case of gasoline taxes (i.e. cents per gallon).  In the case of the United States, for the most part, these gasoline excise taxes are used to fund the construction and maintenance of our highways.  In this way, the excise tax does create jobs as the nation's highway transportation infrastructure is improved.  

Collecting excise taxes on gasoline in the United States began nearly a century ago.  The first state to enact gasoline excise tax legislation was Oregon in 1919; within just over a decade, every state in the Union had enacted its own state-level excise tax.  At that time, state gasoline taxes ranged from 2 to 7 cents per gallon.  The first federal government gasoline general revenue tax appeared in 1932, right during the height of the Great Depression, at the rate of 1 cent per gallon and became a permanent excise tax in 1941.

Gasoline taxes were raised from 4 cents per gallon to 9 cents per gallon under the Reagan Administration in 1983.  The purpose of the increase was to repair American highways and create jobs in an economy that was in the early phase of a recovery.  In 1990, under the Bush I Administration, gasoline taxes were raised by 5.1 to 14.1 cents per gallon, ostensibly to reduce the deficit.  Gasoline taxes were last increased in December of 1993 under the Clinton administration.  Use of the funds raised by that increase of 4.3 cents per gallon to the current level of 18.4 cents per gallon was once again restricted to deficit reduction.

Economists and politicians know that by increasing the level of the excise tax, consumers could be encouraged to increase their use of more fuel-efficient vehicles and may ultimately use more mass transit.  This would result in consumption of less oil and create less air pollution.  On the other hand, an increase in gasoline taxes would affect the pocketbooks of Americans who live in rural areas to a greater degree since they generally have to drive greater distances to access goods and services.  As well, governments have generally proven themselves to be rather poor stewards of tax revenue and the benefits to society by having the revenue in the hands of government may be outweighed by the benefits of leaving the revenue in the hands of the private consumer.

The demand for gasoline is generally considered to be very nearly completely inelastic, that is, a given increase in price results in almost no drop in demand or a drop that is far less than would normally be expected when compared to other goods.  This means that if the federal government decides to increase the excise tax, the revenue recovered from consumers will increase by more than the amount they might lose due to a relatively small drop in demand.  That said, inelasticity in demand can be overcome if price (tax) increases are high enough.  Eventually, gasoline prices will rise high enough that consumers will reach their personal gag point and simply cut back on their consumption.  If we look at historical price and demand data, between 2000 and 2007, gasoline demand rose by 9.6 percent even though the price of gasoline nearly doubled.  As 2007 turned into 2008, gasoline demand dropped as a result of the recession and gasoline prices that exceeded $4 per gallon.  Right now, gasoline demand in the United States is generally around 9 million barrels or 378 million gallons per day (2010 EIA data), down about 3 percent from 2007, largely because of a very weak economy.

At this point in time, the United States federal excise tax on gasoline stands at 18.4 cents per gallon (the equivalent of 4.86 cents per litre, substantially lower than Canada’s rate of 10 cents per litre).  This works out to approximately 5 percent of the average price per gallon (depending on the price at the pump).  Of the 18.4 cents, 18.3 cents is allocated to the Highway Trust Fund and the remaining 0.1 cents is allocated to the charmingly acronymed LUST Fund or Leaking Underground Storage Tank Trust Fund, a fund used to remediate the problems created by America's aging fleet of corroding underground gasoline storage tanks.  In the first three-quarters of fiscal 2011, gasoline excise taxes have generated over $22 billion for the Highway Trust Fund, not particularly a huge amount given the size of Washington’s overall budget.

States and local governments also get their pound of flesh from America's gasoline consumers as well.  These taxes plus the Federal excise tax add between 40 and 50 cents to a gallon of gasoline.  Here's a nifty little map from the American Petroleum Institute showing the total local, state and federal gasoline excise tax burden for all states in the Union:

Note that the average total gasoline excise tax for all states is 48.9 cents per gallon.  Connecticut has the highest gasoline excise tax burden at 68 cents per gallon and Alaska has the lowest at 26.4 cents per gallon.  That’s quite a spread.

Since, as mentioned previously, the price elasticity of demand for gasoline shows it to be extremely inelastic, it will take a very large increase in the level of taxation before consumers will cut their consumption level.  The current level of gasoline excise taxes form a relatively small portion of the price of gasoline.  With gasoline prices averaging around $3.50 per gallon, the federal portion of the excise tax adds only 5 percent to the price of a gallon of gasoline and total taxes add only 14 percent.  With current tax levels, it is very difficult for governments to use gasoline excise taxes to force consumers to switch to more environmentally friendly options.  The tax increases that would be required to change our behaviour would most likely be politically suicidal.

Now, let's take a look at how heavily gasoline consumers are taxed in other jurisdictions.  Here is a bar graph showing the level of fuel taxation for the month of April 2011 for a number of nations:

Note that the United States has by far the lowest fuel tax among all nations on the chart other than Mexico which subsidizes its consumers. Canada comes in second place at just under a dollar per gallon and the United Kingdom comes in fourth from the top at just under $4 per gallon.  Note that some of the EU nations have extremely high levels of fuel tax compared to just about everyone else in the world.

When one looks at the 378 million gallon per day gasoline consumption level and America's very low gasoline excise tax levels in conjunction with the $1 trillion plus deficit and $16.4 trillion debt, one can see where this story could well end up.  It has to be extremely tempting for governments at all levels to stick their hands into Main Street's wallets once again.  Should the Obama Administration make the extremely daring move of increasing gasoline excise taxes to $1 per gallon, that move alone would raise $138 billion annually.  A $2 per gallon excise tax would raise $276 billion and, despite the pain that would be inflicted, gasoline excise taxes would still be well below that of most OECD nations.  While this increased revenue would assure future funding for the Highway Trust Fund and should result in the creation of at least some jobs, it would most likely be political suicide.  As well, in this time of economic weakness, the transfer of funds from consuming taxpayers to Washington could well throw the economy further into a downward spiral.

Apparently, Washington is once again caught between a rock and a very hard and dark place.  Congress is going to be very tempted to raise gasoline excise taxes to achieve the fiscal balance they so badly need.

Reference:

Congressional Research Service - The Role of Federal Gasoline Excise Taxes in Public Policy